Although stock dividends, stock splits, and reverse splits might seem complicated, they are actually simple methods that companies use to enhance functionality and utility by restructuring equity without altering the overall value of the business. Even though these actions don’t directly affect a firm’s total market worth, they can significantly influence how investors view the company and how easily people can buy and sell the stock. By exploring each of these methods and mixing in insights about how companies aim for a “preferred trading range,” to send signals to investors or improve liquidity, we can get a clearer sense of why these moves matter and how they shape the market’s perception (Brooks, p.600). Companies often use these tools not only to shape perception but also to attract a broader range of investors by aligning share prices with market expectations (DeAngelo et al., 2009).

Stock dividends are the stocks that a company gives out to current shareholders rather than giving them dividends in the form of cash. Stock dividends can be likened to the company giving thank you gifts to stockholders in the form of stocks rather than money. A very common textbook example of stock dividends is when a company announces a % amount of stock dividend they are going to issue, which results in every shareholder being issued that % amount more of the amount of stock they already own (Brooks, p.600). This is a nice thing for companies to do, because stockholders end up with more shares, but the value of what they end up owning at that point does not usually go up. The price per share usually decreases at the point when a company issues a stock dividend because of the simple fact that there is an increase in the number of shares in circulation. It is simply having the same percentage of the stockholder owned total number of shares in circulation. The reason why it is not a hollow gesture is because it signals to investors that a company believes in the projects they are opting to put cash into rather than issuing cash dividends, and that they are doing so in order to make stock prices go upwards and want shareholders to have more stocks in order to show appreciation. Shareholders generally take stock dividends as a positive message, especially if they are holding a company’s stocks for the long run. Still, it’s key to remember that, on its own, a stock dividend doesn’t boost anyone’s actual wealth (Brooks, p.600). Many long-term investors interpret such dividends as a reflection of future growth expectations (DeAngelo et al., 2009).

Stock splits are basically slicing shares into a larger number of smaller shares which are more manageable. It can be likened to having a really big slice of pizza which is way too big for a single individual to eat, so they cut it or “split” it into two or even three smaller pieces making it easier to share. This is what a company can do when their stock price climbs too high and ends up at a point where it feels “too expensive” for many investors. Firms will end up doing a 2-for-2 or a 3-for-1 split. This means each share that initially exists at that point will be divided into multiple new ones, dropping the share price to a lower and “less expensive” feeling level (Brooks, p.601). The range that is reached after a properly structured stock split is what many people call the “preferred trading range” and is a comfortable zone where too high so that it scares away basic normal investors, but at the same time it is not so low so that it ends up looking like the company is in trouble. People typically have seen prices at around several to a few tens of dollars as the best sweet spot, but opinions vary. When companies split stock, it creates a buzz and by this they hope to create more buyers and also boost liquidity (Brooks, p.601–602). In this context, “liquidity” means the ease with which stocks can be traded without large resultant swings in the price. The more approachable the share price, the smoother and more frequent the transactions tend to be due to the fact that there are simply more people who end up wanting to buy and sell. There is also the additional psychological factor of a split sending the message that the management who decided to do the stock split feel it was a legitimate run up in stock price and therefore it is a justified split which will result in more profit because the management does not intend for the smaller sized stocks to shrink, but to grow because of internal factors that cause them to see even more potential on the horizon (Brooks, p.602). Recent studies suggest that post-split companies often outperform the market in the short term due to increased retail investor activity (DeAngelo et al., 2009).

Stocks splits are not magic, and they do not make a company more valuable.  A $100 stock split into two $50 shares still holds the same total value.  What might be akin to magic is the real-world human response that occurs when potential new buyers jump in due to the extra attention caused by a split.  This can give a stock price an upward bump over the short term.  Managers can use stock splits to “signal” confidence by conveying the message that the company must be doing well or else they would not bother to split the stock.  The phenomenon has been called the signal hypothesis, and it suggests that a split is management’s way of nudging investors so that they begin to see the company’s strong performance as a trend that will hopefully continue (Brooks, p.601).

A reverse split goes in the opposite direction of a stock split. A reverse split is like taking several small slices of pizza and somehow putting them back together into one larger slice. Sometimes stock prices drop below what major exchanges consider acceptable. When a company’s stock drops to a low enough price, it might do something like a 1-for-10 reverse split, which means that 10 shares at $1 each will be combined into 1 share worth $10 (Brooks, p.603). The stocks hold the same total value, but the share price looks a considerable amount higher. Companies can avoid getting kicked off stock exchanges this way because stock exchanges typically have rules about minimum share prices. Some investors and big institutions might view the company as more stable and/or appealing because they won’t touch stocks that seem too much like “penny stocks.” In many ways a reverse split is a simple way to groom a stock to keep it looking as good as possible. In other ways, investors will sometimes see reverse splits as warning signs. A reverse split can suggest that stock has already taken a big hit. If the company doesn’t address the underlying issues that caused the price to fall, then boosting the price through consolidation might only be a band-aid solution (Brooks, p.603). For that reason, analysts often caution investors to focus on revenue trends and cost control after a reverse split announcement (DeAngelo et al., 2009).

What’s interesting is that all three of these moves, stock dividends, stock splits, and reverse splits, don’t change the overall value of the company itself. The pie remains the same size; it is just being cut differently (Brooks, p.600–602).  The perception of a company’s stocks and of a company can shift quite a bit even though the total value of its stocks doesn’t change.  If a shareholder believes in the company’s future, a stock dividend will end up feeling like a bonus to them.  New investors might feel a stock split as a friendly gesture communicating a company’s desire for them to be able to afford their shares.  A reverse split can signal to investors that a company is doing what it takes to keep their stocks from sinking any lower and that they are taking steps to look more respectable.  Each of these moves, then, is partly about investor psychology and partly about practical concerns like meeting exchange requirements or making shares easier to trade.

There are several reasons why companies do stock splits in the first place.  One main reason is the fact that a lot of investors have a preferred price range within which they will buy and sell.  If the price gets to be too high, regular people won’t generally feel they can afford even a single share, let alone around 100 shares (Brooks, p.601).  When a company splits its stocks, it opens the doors to a larger group of potential investors.  Another reason why companies split stocks is because the accessibility of the price range stimulates trading activity.  The hope is that increased trading will lead to a more stable price in the long term due to the fact that each individual trade has a smaller impact because there are so many shares being traded. Signaling is another element.  When a company’s stock price soars, a split is very often seen as a subtle nod that management has an inside confident expectation that things are going to continue going well for the company (Brooks, p.601-602).

Typically, the only real reason for a reverse split is to fix a low stock price that is on the borderline of being delisted from exchanges.  Exchanges have rules about minimum stock prices below which a stock must be removed from the exchange platform (Brooks, p.603).  Companies work to avoid being delisted from stock exchanges because it means losing access to a great number of investors. A reverse split quickly adjusts the price per share upwards by a multiplier of the number of shares that are combined, and this can quickly raise the price above the delisting danger zone.  Because different institutional investors avoid very cheap stocks, a reverse split can make a company that does a reverse split appear less risky.  It is not an invisible remedy though; some investors see reverse splits as red flags indicating that a company’s stock was in the middle of a downward trajectory, and they see the reverse split as only a grooming activity.  Firms also have to work on fundamentals like boosting sales, cutting costs and/or launching new products to keep investors interested. A reverse split will help a company stay above water, but it will not automatically fix core issues that may have caused the stock price to drop.  These things have to be dealt with in a systematic pattern if a company wants to stay solvent.

Stock dividends have a different pattern of where they fit in a business strategy.  They are often used when a company wants to reward and incentivize shareholders to continue to hold stocks, but they do not want to pay out cash.  Businesses might have a plan for a big internal project they hope will bring better profits or more efficiency, maybe they want to expand into a new set of markets of work on a new technology innovation.  Whatever the reason, banks often want to keep their cash in the bank and so they give shareholders stock dividends (Brooks, p.600).  Stock dividends are a way not only for companies to communicate their appreciation for their shareholders, but for them to prove it by rewarding them.  Shareholders like stock dividends because it communicates the existence of high enough internal managerial confidence in the business for the company to keep their money in-house.  It still leaves the real question as to whether a company has good long-term prospects and will reach its goals, the same way as cash dividends does.  The extra shares in and of themselves do not financially enrich the shareholder.  It is a simple reflection as to how management is deciding to handle the expected profits.

Despite the different technical things occurring in these three actions, they share the common thread concept of functioning in a way that manages appearances and practicality.  Stock splits are seen as “feel-good” moves in already healthy companies, whereas reverse splits are more like “rescue” moves in troubled companies (Brooks, p.602-603).  A stock dividend is probably somewhere in between the two, used often by companies that are doing well, but have a desire to keep cash inside of the business.  Investors must look beyond the surface.  A stock split can generate excitement, but it is important to research whether a company has strong fundamentals to keep itself healthy.  A reverse split will keep a company on a major exchange, but it still needs a solid plan to improve profitability.  A stock dividend, though signaling managerial confidence, does not necessarily mean the business has a good record of using retained earnings as well as it should.

 

BIBLIOGRAPHY:

Brooks, R. (2023). Financial management core concepts (4th ed., pp. 344-352, 361, 388). Pearson.

DeAngelo, Harry and DeAngelo, Linda and Skinner, Douglas J., Corporate Payout Policy (May 7, 2009). Foundations and Trends in Finance, Vol. 3, Nos. 2-3, pp. 95-287, 2008, Available at SSRN: https://ssrn.com/abstract=1400682