Unlocking the potential of stock splits

Corporate actions are important in shaping investor sentiment and activating market activity in the rapidly changing financial markets.

However, out of all those activities, stock splitting is among the strategic tools that can help increase any listed company’s liquidity, attract a wider investor base, and help keep a company abreast with best international practices.

Recently, this mechanism has gained renewed attention with the introduction of Stock Split Guidelines by Pakistan Stock Exchange (PSX) and its subsequent approval by Securities and Exchange Commission of Pakistan (SECP).

This article explores the concept of stock splits, their significance, and the benefits they offer to list companies on PSX.

A stock split is a corporate action where the company increases the number of outstanding shares by reducing the face value and issuance of additional shares to existing shareholders. This will proportionally reduce the price per share while keeping the market capitalisation of the company unchanged.

For example, in the case of a 2-for-1 stock split, for every share owned by a shareholder, an extra share is issued, and the stock price is reduced to half.

A key reason for a stock split is to reduce the share prices so that investors find shares more affordable and easily reachable, thus increasing market liquidity and trading activity. Per-share price decreases while an investor’s intrinsic value in holding stays intact because the total value has been divided into more shares.

At times, stock splits are resorted to by a company when its stock price has risen to a very high level due to which it remains out of the popular trading range.

Desire of the management of a company to have diffused ownership can be another reason for stock splits.

Essentially, there are two types of stock splits. Forward Stock Split and Reverse Stock Split. Forward Stock Split is the most common type of split where with the rise in number of shares, the prices of the shares decline proportionately. For instance, in a 3-for-1 split, every shareholder gets three shares for every share they hold while the share price decreases to one-third.

The other type of stock split is the Reverse Stock Split whereby the number of shares decreases and the price per share increases proportionately. This is done to meet regulatory requirements or to make a stock presentable and accessible.

In any case, stock splits result in no change in a company’s cash flows, paid-up capital or shareholder’s equity.

Companies engage in stock split due to several reasons. For reasons of practicality, we will consider the Forward Stock Split. At the outset, it is clear to see that lower share prices for a stock split make it easier for investors buy and sell shares. This increases volume of trading and liquidity in the market. Moreover, this increased activity can lead to more accurate and efficient price discovery. As high-priced shares can deter small investors, a stock split reduces the price per share, which makes the stock more accessible to a wider range of investors, including retail participants.

A stock split is usually considered an indicator of good performance and future growth prospects. This can increase investor confidence and subsequently increase demand for the company’s shares.

Although the net worth of an investor’s portfolio does not change, this increase in the affordability of shares leads to higher demand and might increase the stock market value over time.

Additionally, lowered share prices post-split make Employee Stock-Ownership Plans more attractive and accessible to employees, an effective tool for talent retention and motivation.

Essentially, a stock split is often seen as a positive indicator that a company is growing. Companies that split their stocks have typically enjoyed a big jump in share prices. However, just because a company declares a stock split, it does not mean that the stock price will inevitably rise in reaction.

There are many other variables that influence investor’s decisions in the result of a stock split including earnings, market stability, interest rates, etc.

Pakistan Stock Exchange has introduced Stock Split Guidelines to ensure the promotion of market inclusivity and align the Exchange more with international standards. The guidelines align PSX with international best practices with the prospect of making Pakistan’s capital market more competitive and attractive to foreign investors. It specially targets institutional investors who respect international standards.

In terms of liquidity, PSX sees stock splits as a positive development making shares more affordable for retail investors by reducing price per share, encouraging higher trading volumes.

As mentioned earlier, increased liquidity leads to a more efficient price discovery endorsing the fact that increased liquidity benefits both investors and the market.

As it is, stock splits lower the entry barrier for small investors, fostering financial inclusion. This democratisation of stock ownership contributes to a more vibrant and diverse investor base.

Furthermore, companies that split their stocks also express confidence in their prospects of growth. This optimism could be the basis for attracting domestic as well as international investors toward PSX, thus generally increasing its attractiveness.

Stock splits lead to market depth and stability as increased participation from retail investors will help to diversify the investor base, reduce market concentration, and increase stability.

Though stock splitting has many benefits, the decision to conduct such an action should not be taken lightly by any corporation. There are a few considerations that must be kept in perspective. These include market conditions, growth prospects, communication strategy and regulatory compliance.

The prevailing market conditions and investor sentiment must be understood well before the companies undertake the process of stock splits.

A stock split is most effective when supported by good financial performance and growth potential. A company should have a sound track record and positive outlook before going for it.

Moreover, companies need to clearly state the reasons for and benefits of the stock split. Transparency and effective communication with stakeholders will ensure understanding and trust in the decision.

In terms of regulatory compliance, companies need to learn the regulatory requirements; they should obtain professional advice in this respect from advisors, regulatory or financial. Compliance with PSX and SECP rules and regulations is imperative to keep the process clear and transparent.

The issued guidelines on the stock splits by PSX and approved by SECP clearly provide an outline for a company to conduct the stock split. The process flow involves conducting analysis by a company in order to evaluate share price, market conditions, and sentiment to determine the need for a stock split.

Furthermore, the process involves consulting advisors, holding a board meeting to discuss and approve stock splits and determining split ratio.

For the board to approve stock split, the board of directors must authorise stock split as well as the split ratio. Subsequent to these steps, a company is to announce the stock split and disseminate the decision through the PSX data portal company announcements section.

Thereafter, a general meeting is held to obtain shareholder approval via special resolution, and the resolution is then to be adopted by approving changes in the Memorandum & Articles of Association. The resolution results are then disseminated on the PSX website by the company.

The next steps of the process involve updating shareholder accounts to reflect the new shares issued post-split, temporarily suspend trading in the shares of the company on book closure basis to implement the stock split, coordinate with CDC to issue new shares, and submit Form 26 along with the special resolution and amended documents to the SECP.

Furthermore, the company is to confirm with PSX regarding induction of new shares into respective CDC accounts of shareholders, amend share capital structure by updating the company’s records and financial statements to reflect the changes, as well as submit Form 3 to SECP in order to report the post-split share capital and number of shares.

The company must declare its intention of performing a stock split in the press, including such details as the split ratio, record date, and effective date.

On the effective date, the company implements the stock split, and the company’s shares will start trading at the new adjusted price. Post-split, the company must adjust its records such as share certificates and ensure dividends and other calculations are based on the new share structure.

It is important to consider the challenges and risks posed by stock splits. One of these is market misinterpretation whereby investors may misinterpret a stock split as a sign of over-valuation, among other negative indicators. Therefore, it is essential to disseminate clear communication to avoid such miscommunication.

The administrative costs involved in implementing a stock split must also be considered. These include regulatory filings, shareholder communications, and record adjustments.

It is also pertinent to note that stock splits can create volatility as a risk factor in the short run due to reactions from investors to stock split announcement and implementation.

For listed companies, stock splits offer a powerful tool to increase liquidity, attract a broader investor base, and signal growth potential. However, the decision to undertake a stock split should be based on a thorough evaluation of market conditions, growth prospects, and stakeholder expectations.

The introduction of Stock Split Guidelines by PSX and its subsequent approval by SECP marks a significant step toward modernising Pakistan’s capital market and fostering greater inclusivity.

For many investors who want to invest in blue chip companies for long term investing, whether for capital gain or dividend yield, some blue-chip companies may be out of reach. For such companies to attract interest from investors, it would be feasible for them take advantage of the stock split corporate action.

This will not only spell out benefits for the investors and companies themselves but will also be advantageous for the capital market depth and growth.

Whereas PSX has introduced the One-Share Marketable Lot recently, to facilitate investors to purchase even one share of listed companies, nevertheless the cost of one share of certain companies may still be expensive for many investors. In such a case, stock splits are highly advantageous.

By taking advantage of stock split dividends and following the overall regulatory framework, companies can strengthen their market presence, increase their shareholder value, and contribute to further development of Pakistan’s capital market.

As PSX continues to take its place formidably, stock splits can be one of the important factors that can help shape the future of the Exchange and spur economic growth going forward.

(The contents of this article comprising of information pertaining to financial products, including but not limited to securities, derivatives products, listed companies or companies proposed to be listed on PSX and any content of third parties are strictly of a general nature and are provided for informative and educational purposes only)

Copyright Business Recorder, 2025