A forward stock split is a maneuver strategy whereby listed companies increase the number of shares available. Are you interested in learning all about it and how it differs from the reverse stock split? And want to understand through examples why it’s important? Then our today’s guide is all that you need. Keep reading to know what is a forward stock split and why do companies adopt this technique? Let’s dive deep straightaway.
What is a forward stock split?
Analysts define a forward stock split as a maneuver wherein a publicly listed company increases the number of shares available. However, the total value of the shares remains the same. In other words, a stock split is a strategy that involves splitting existing shares into two or less valuable shares. So, the number of shares increases but the value of each share declines. Therefore, the overall impact on the overall value of the stocks is nil.
How does it work?
A forward stock split, as we already know, increases the number of shares of a company but the overall value of that company’s stock remains the same. It is because companies split stocks by using a specific split ratio. Company’s board of directors decide the ratio. They may choose whichever ratio they deem suitable. However, there are some common ratios that different companies have used over the years.
- 2 for 1 split ratio – Companies using 2 for 1 split ratio split each share into two. That means, if a company had previously 1,000 shares, it now has 2,000 shares. So the number of shares increases. On the other hand, the value of each share becomes half of the pre-split share price. That means if the old share price was $1, now it has $0.5. That said, the total value of available shares remains the same.
- 3 for 1 split ratio – Companies using 3 for 1 split ratio split each share into three. On the other hand, the new price of the increased number of shares will be one-third of the old price.
- 5 for 1 split ratio – Companies using 5 for 1 split ratio split each share into 5 shares. Whereas, the new price of the increased number of shares will be one-fifth of the old price.
However, the aforementioned ratios are among the highly used split ratios. Other common split ratios include 8 for 1, 10 for 1, or 3 for 2. That said, the higher hierarchy of a company makes the final decision on how they want to split shares.
Why do companies enact forward stock splits?
Companies decide to split shares because of a couple of reasons;
- Companies may split the stocks to bring the stock price to the level of their direct competitors. It happens when a company’s stock price rises significantly high as compared to its peers.
- Secondly, companies may also split the stocks to keep stock prices inaccessible to the average investor. It serves companies in two different ways. Firstly, the split increases liquidity as the number of available shares increases. On the other hand, lower stock prices make it attractive for retail investors. As you know, big players and institutional investors have loads of capital to buy shares of a company at any price. However, average investors with limited capital cannot afford to buy shares with high prices.
Forward stock split examples
Lots of companies have enacted forward stock splits over the years. There are numerous examples you can quote. However, let’s look at the most recent example where one of the world’s largest companies performed stock split. We are talking about Apple. It enacted stock split using a 4 for 1 split ratio. Apple’s available shares were 12.6 billion and its stock price was $500 approximately before the forward stock split. After the split, the number of outstanding shares increased to 50.4 billion whereas the stock price was reduced to just $125. Thus, Apple brought its share price to the accessible range of an average investor while increasing its liquidity.
Long-term effects of forwarding stock split
Although a forward stock split only increases the number of available shares of a company and doesn’t affect the overall value of the shares, it stirs up interest. As we have discussed a short while ago, companies enact stock splits to increase liquidity and make their shares accessible to retail investors. Therefore, it entices investors of all sizes to invest in the company. Although these effects don’t last for long, a repeated stock split positively affects a company’s share price. In short, investors start considering that company as healthy with significant growth potential. You better know what happens when investors begin to think positively about a company! Boom!
Forward stock split v reverse stock split
A reverse stock split is the inverse of a forward stock split. As we know, a forward split involves splitting existing shares into 2 or more but without diluting the overall value of available shares. It means the number of shares isn’t increased through a secondary offering. Instead, new shares are equally divided between the existing shareholders. Moreover, the company enacting a stock split doesn’t make money but only maneuvers the number of available shares. Moreover, it is generally considered a good idea because it stirs interest among investors. It also indicates the high demand of a company and the market’s ability to support more supply.
As a reverse stock split is the opposite of a forward split, it involves consolidating existing shares to fewer shares. The price goes up as a result of the consolidation because the number of outstanding shares reduces. So, is it a good idea? After all, the share price increases instead of decreasing as it happens in a forward split. The answer is “no.” A reverse stock split isn’t a good idea despite the fact that it brings an increase in share price.
Why does a reverse stock split not a good thing? It is not because companies increase their share prices without adding value to their businesses. So, why do companies enact a reverse stock split if it isn’t a good idea? Companies do so because they have to meet the listing requirements of stock exchanges. When prices begin to fall, companies consolidate shares into a fewer number of shares. As a result of consolidation, share prices increase.
Stock splitting is a technique that companies adopt to their advantage. There are two types of stock splitting – a forward stock split and a reverse stock split. The former involves increasing the number of available shares by dividing existing shares into two or more shares. It doesn’t affect the overall value of the outstanding shares. Companies enact this maneuvering to increase volatility and stir interests among investors. Some companies also split stock forward because they want to bring share prices within the accessible range of average investors.
A reverse stock split, on the other hand, involves the consolidation of existing shares to decrease the number of available shares. As a result of it, share prices increase but nothing increases the overall value of a company. Companies do this just to meet listing requirements or to entice large investors who generally ignore stocks of lower value. That’s why a reverse stock split is often considered a bad idea.