Stock Operations
In the area of finance and investing, particular corporate activities have the potential to significantly impact the configuration and features of a company’s stock. This is because of the nature of the stock itself. The activities that fall under this category include stock dividends, stock splits, and reverse splits, all of which have different functions. The most effective course of action is routinely evaluated by businesses depending on several other reasons.
Stock Dividend
A stock dividend refers to allocating extra shares of a company to its current shareholders proportionate to the number of shares they currently possess. A company’s board typically declares a stock dividend of directors as a means of rewarding shareholders without incurring any cash outflows (Priyapriya, 2023). When a corporation declares a stock dividend, the overall quantity of outstanding shares rises, yet the proportional ownership of each shareholder remains constant.For instance, when a company announces a 10% stock dividend, a shareholder with an initial holding of 100 shares would be entitled to an extra 10, resulting in a total ownership of 110. Companies frequently utilize stock dividends to communicate their financial well-being and optimism regarding their future growth opportunities while also serving as a form of appreciation for dedicated shareholders. Although they do not lead to a direct monetary distribution to shareholders, they can favorably influence the company’s stock price and investor sentiment.
Stock dividends can be of three major types: regular, unique, and property. Regular stock dividends represent the most prevalent form of stock dividend. The company’s board of directors determines the dividends, which are disseminated to shareholders periodically, typically on a quarterly, semi-annual, or annual basis. The dividend is generally a modest percentage of the company’s stock, typically around 1% to 2%. On the other hand, special stock dividends are non-recurring allocations of extra shares to stockholders. A corporation’s board of directors commonly authorizes dividends to allocate surplus profits, capital, or reserves to stockholders. Special stock dividends typically exceed the size of regular stock dividends, falling within the range of 5% to 25% of the company’s stock. Lastly, in a property dividend, rather than giving shareholders cash or more shares of stock, the corporation transfers assets like a subsidiary or property to them. Compared to dividends on regular and special stocks, property dividends are rarer and sometimes more challenging to assess.
Stock Split
A stock split is a corporate action taken by a company to increase the number of shares outstanding when the stock price is deemed to be overvalued, thus making it more accessible for investors to purchase. The announcement of a stock split is considered significant information for investors in their decision-making process, as it can lead to increased demand for shares and enhance the liquidity of the shares.According to signaling theory, a stock split is a positive indication from the company to the public on its prospects (Bacon & Spradlin, 2019). Managers will only split stocks if they are optimistic that future shares will increase or remain stable. If managers anticipate a decrease in future share prices, they will refrain from splitting stocks due to the higher costs of trading at lower prices. Another stock split is seen as a statement from management that the company has promising prospects.Common split ratios are 2-for-1 or 3-for-1, also represented as 2:1 or 3:1 (Stock Splits”, n.d). This indicates that after the split, each investor will get two or three shares for every share they held before respectively.
Reasons for Stock Split
First, companies could split their stock to increase the affordability of their shares for individual investors. For instance, when a stock is valued at $1000 per share and the company executes a 2-for-1 stock split, the price per share would be reduced by half to $500. This could enhance the accessibility of the stock to individuals who might not have the financial means to purchase a $1000 share but could manage a $500 share. Second, to enhance the liquidity of the stock. With more shares available, investors may find it more convenient to buy and sell on the open market (“Stock Splits,” n.d). This phenomenon can enhance the stock’s appeal to institutional investors who require the ability to execute transactions involving significant quantities of shares promptly and effectively. Lastly, some companies posit that stock splits signal to the market that the company is performing well and that its stock is expected to appreciate further. This phenomenon can enhance investor confidence and entice new investors to engage with the stock.
Reverse Split
A reverse stock split is a strategic action implemented by a publicly traded company to decrease the total number of its outstanding shares available in the market. Shares that currently exist are merged into a smaller number of shares. This phenomenon leads to an increase in the stock price of the shares without an immediate impact on the overall value of the stock to the investor or the stock’s market capitalization (Bacon & Spradlin, 2019). For instance, when a stock is valued at 50 cents in the market, and a company announces a two-for-one reverse stock split, an investor holding 100 shares valued at 50 cents would then possess 50 shares valued at $1 each.
When a reverse stock split is implemented, a company voids its existing outstanding stock and issues new shares to its shareholders based on the number of shares they held before the reverse split. For instance, in a one-for-ten (1:10) reverse split, shareholders are allocated one share of the company’s new stock for every ten shares previously held. Each subsequent share would have a value tenfold higher than the shares before the split. Following the completion of the reverse stock split, a shareholder with 1,000 shares would be left with 100 shares.
A reverse stock split does not immediately impact the company’s value, as its total market capitalization remains unchanged. Also, it does not immediately impact the stock’s value for the investor (Bacon & Spradlin, 2019). Nevertheless, investors frequently perceive a reverse stock split negatively and interpret it as an indication of financial distress within the company. Following a reverse stock split, it is common for a decrease in market value to occur as investors divest themselves of their shares.
Reasons for a Reverse Split
A corporation may choose to implement a reverse stock split to decrease its outstanding shares in the market for several reasons. First, to avoid delisting. A stock must maintain a price over $1 to comply with stock exchanges’ minimum share price regulations (CFI, n.d). The company’s shares transition into “penny stock” status and are exclusively traded as over-the-counter equities. Second, to enhance the organization’s reputation. A stock trading at a low single-digit price is commonly perceived as a high-risk investment. A reverse stock split creates the misleading impression of a higher stock value. Third, to enhance interest in the stock. Higher-valued equities tend to garner increased interest from financial analysts and receive more extensive coverage in the business news media. An organization that receives little attention from analysts and the media is at risk of fading into obscurity. Lastly, it enhances trading activity in the stock market. Numerous institutional investors and mutual funds typically avoid investing in stocks valued at less than a predetermined price, frequently around $1 or lower. Enhancing the stock price, even through artificial means, may lead to an increase in stock acquisition.
Conclusion
The dynamics of a company’s stock are greatly influenced by corporate operations such as stock dividends, splits, and reverse splits from time to time. Shareholders are rewarded with additional shares through stock dividends, which indicate the company’s financial health and future growth potential. The rise in share accessibility and liquidity resulting from stock splits indicates favorable prospects. Through reverse splits, shares can be consolidated to prevent delisting, boost reputation, attract interest, and enhance trading activity. In general, stock dividends and splits boost investor confidence; however, reverse splits may initially cause investors to be concerned.
References
Bacon, F. W., & Spradlin, K. M. (2019). Forward and Reverse Stock Splits: A Test of Market Efficiency. Journal of Applied Business and Economics, 21(5), 18–28.https://www.longwood.edu/media/student-research/public-site/proposal-examples/Senior-Thesis-Proposal-Example-3-Business.pdf
Priyapriya. (2023, August 2). Difference between stock dividend and stock split. Geeks for Geeks.https://www.geeksforgeeks.org/difference-between-stock-dividend-and-stock-split/
Corporate Finance Institute. (n.d). Reverse stock split.https://corporatefinanceinstitute.com/resources/career-map/sell-side/capital-markets/reverse-stock-split/
Stock Splits. (n.d). Finra.https://www.finra.org/investors/investing/investment-products/stocks/stock-splits
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