Imagine this: You wake up one day and suddenly have more shares in your portfolio in a certain company. Do you think that’s possible? Of course, it is, but you won’t be richer since they have been divided into smaller parts. In this article, we face two very common terms in financial jargon: split and reverse split. But what is a split and contrasplit? Why is it done?
Next, we reveal why they are a common practice that listed companies carry out when managing their shares.
What is a split?
The stock market terminology is full of terms from English. One of them is known as a split. It is a very simple concept, but it is even simpler if we stick to the etymology of the word. In English, split means “divide”, and that is exactly what is done with the shares.
A split is nothing more than a division of the value of a company’s shares. In such a way, the price at which they are quoted becomes lower, in the same measure that there is a greater number of shares. Let’s take the example of a company’s shares that have a value of 200 €. When a split is made on them, expressed in proportion 4:1, it means that the value of one share is divided by 4. Therefore, each share will now cost 50 € instead of 200 € and now there will be four times more shares in circulation.
The split does not change the company’s market capitalization at all, that is, it will still be worth the same. It only has an effect when presenting those shares, which will be more numerous. For any investor, especially those small ones who want to get into the shareholding of a company, it is much easier to do so in those whose titles have a lower price. The saying “divide and conquer” is aptly applied when a split strategy is carried out.
Therefore, if the split does not affect the company’s stock market capitalization, it will not affect the shareholder’s position within it either, since they will still maintain the same position. Continuing with the example, if the shareholder owned 4 shares at 200 € each, and there has been a 4:1 split, now they will own 16 shares valued at 50 € each. Their position remains exactly the same.
Why is a split done?
Mainly for the following two reasons:
- Increase liquidity: When a company is growing, generally so does the value of its shares. If it reaches a value that is too high, liquidity can be affected. In the same way, a great psychological barrier is put to those small investors who would like to buy some package of shares.
By applying the split, trading volume is automatically favored, since, by reducing the value, these shares are much more accessible.
You might be interested in the stock valuation of companies in the stock market. If you are, check out our guide on the Fundamental analysis of companies in the stock market.
- Less concentration of power: Likewise, as the total number of shares is multiplied by the number that has been decided, the shareholders are completely fractioned, which means an impediment when it comes to exercising unwanted control over that company, due to the fact that it is more difficult to take full control of it.
Any company can carry out this operation, which can be a significant advantage when it comes to encouraging the entry of new investors. It is best to discard the idea that it is an operation that implies a sign of weakness. In addition, for shareholders, it does not imply any kind of change. However, for the company, it has a strong psychological component, since what it is looking for is greater accessibility.
Speaking of the entry of new investors, we have something for them. If you’re a newbie, check out our article on the stock market explained.
Example of Amazon’s split on the stock exchange
An example of a split we have recently found in the case of Amazon (AMZN), where we saw that its shares went to quote more than 2,000 $ each, to 100 $ the share.
And it is that around March 2022, Amazon approved to carry out a split of 20:1 of the value of its shares. Of course, the division of the shares gave its shareholders twenty shares for each one they possessed at that time, at the same time that they reduced the nominal value of each share by 20 times.
For this reason, it was not surprising that last June 1, 2022, we saw the quotation of Amazon at such “affordable” prices. In fact, that was the main intention of the company, to make Amazon’s shares more attractive to encourage more people to invest in the company.
Other examples of splits within the large firms were carried out by Apple (AAPL), Tesla (TSLA) or Google (GOOG).
Advantages and disadvantages of carrying out a split
|✅ Greater promotion of the action due to the media boom.||❌ Causes confusion among small investors|
|✅ Greater access to small investors can be achieved thanks to the reduction in the quotation price.||❌ Retail investor sales due to disbelief|
|✅ The price anchor bias comes into play, that is, seeing it now cheaper than its previous price, will get more investors to buy the stock.|
👉 To know the most important corporate operations, you can visit our next article: How to invest in the stock market?
What is a contra-split?
And in the same way that there is the split, there is also the contra split, which is exactly the opposite of the split. Therefore, a contrasplit is a grouping of the shares of a company, in such a way that in the same proportion that they are grouped, the price must be increased.
In other words, instead of a division operation, a multiplication of the value of that share by the number that is joined is performed. Let’s say, for example, that a company performs a 6:1 reverse split and that the shares of that company cost 5 euros, When performing that reverse split operation, 6 shares are grouped into 1, and each of them, from now on, will cost 30 €.
The reverse split has the same effect on the shareholder as the split, that is, none. The shareholder owns a smaller number of shares, but the total value of what has been invested does not change at all.
Why is a reverse split done?
It is not a very common practice, but the companies that resort to it do so for the following reasons:
- Shares with very low prices: In this type of situation, low prices usually give rise to high volatility, and precisely what a reverse split seeks is to reduce volatility. With a small share price, margins can lead to high variations.
- Better psychological price: And in the same way that a share price of 4 digits (above 1,000 $), can be perceived as high, performing a reverse split can help with a change of image.
Sometimes the share prices are so low, even less than one dollar, that they give the feeling of being penny stocks or values with little future. If the company’s shares go from a low value to a higher one, it usually projects the feeling that it is a company with much greater business volume, at least for the less experienced investor, which can help attract a little more volume.
Example of Pharmamar’s reverse split on the stock exchange
And in the opposite case, we have the example of Pharmamar (PHM.MC), a pharmaceutical research laboratory that is part of the IBEX 35.
In this way, at the Shareholders’ Meeting held on June 22, 2020, they decided to carry out a reverse split of 12:1, that is, for every 12 shares in circulation, after 30 days, there would only be one, and the value of its shares would be multiplied by 12.
Consequently, on July 22, 2020, the shares went from the 9.56 euros they were trading at to 114.7, that is, an increase of 12 times their price.
Behind this was the fact that the nominal value of its shares would go from 0.05 euros to 0.60 euros per unit.
Another example of a reverse split can be found in the airline Norwegian Air (NAS.OL)
Advantages and disadvantages of carrying out a reverse split
|✅ Greater promotion of the company due to the stir generated by the news||❌ Generate distrust in shareholders|
|✅ Psychological biases come into play that make the investor believe more in his investment||❌ That investors think it is not a serious company|
|✅ The higher the stock price, the more people tend to think it is a better asset to put their money in. More security|
In conclusion, we could refer to the fact that both the split and contrasplit had no effect on the stock value of that company at the time of its realization. Shareholders still have the same money invested, but they will have a greater number of shares in the case of the split, and fewer in the contra split.
The objective of both operations is to protect the company from the possible negative effects of having an inadequate number of shares, to facilitate the operation, and to attract more investment.
What is a split in the stock market?
A split is the division of a company’s shares into smaller parts, reducing the price of each share while increasing the number of shares.
How does a stock split affect a shareholder’s position?
A stock split doesn’t change a shareholder’s position in terms of value. They own more shares at a lower price, but the total value remains the same.
How do stock splits and reverse splits affect a company’s overall value?
Stock splits and reverse splits don’t change a company’s overall value; they only affect the number and price of shares.