Stock splits are essential to the growth of a company. Even though it sounds like a big deal, it is basically like getting four quarter coins for a dollar bill. What split stocks essentially mean is that a single stock is split into many. This divides the prices of one single stock into many. Here are a few key reasons behind the practice of splitting stocks.
To gain more shareholders
When a company is incorporated, it usually has a certain number of shareholders. Since the company cannot go and issue more stocks than the 100% its investor/stockholders already own, it simply splits the existing stocks to allow old stockholders to sell some of their stocks to new investors without incurring a major loss. For example, imagine a company launched an IPO with 300 stocks. After a while, the company wants to raise some more money from the public but it cannot simply issue new stock. So it splits the existing 300 stocks and now it has 600 stocks. This allows the existing stockholders to own twice as many stocks valued at half the price of the original. Now these shareholders can sell off some of their shares to make a profit if they wish.
To gain investors of all buying capacities
Companies often prefer having a mixed bag of investors rather than 2-3 big investors. Since stocks directly translate into ownership of the company, it is preferable for a company to have stock holders of all buying capacities to prevent a few stockholders from monopolizing control of the company. When a company splits stocks, it allows investors of all buying capacities to have a chance of buying a stock of a company. Having a diverse stockholder base is better for the liquidity and marketability of a company.
To reduce the cost of a single stock
If Coca Cola had never split its stocks, a single its stocks today would be valued at around $200K. That of course wouldn’t be within the reach of every investor. Over its 80 year history, Coca Cola has split its stocks so many times that a single stock from the time of its IPO would be equal to around 4,900 stocks today! By reducing the cost of a single stock over time, Coca Cola has earned, well, gazillions.
