A stock split is a corporate action in which a company divides its capital stock into smaller units. Generally, the purpose of a stock split is to increase liquidity and boost the marketability of a company’s stock. To understand the rationale behind this corporate action, let us look at its fundamentals.

When a company performs a stock split, the number of shares outstanding increases while its total market capitalization remains the same. To maintain the market capitalization, the price per share of the split stock is proportionally reduced. For example, a 2-for-1 stock split results in two shares for each one existing share, so the share price is cut in half. Likewise, if a 3-for-1 stock split is issued, the price of the stock per share is reduced by a third.

A key benefit of a stock split is that it makes the stock more accessible to smaller investors by reducing the cost per share and consequently making it more affordable for them to purchase. With lower share price, stocks become more attractive to retail investors and further, to mutual funds and institutional investors as well. These activities, in turn, increase the trading volume of the stock and boost its liquidity.

It is to be noted that reverse stock splits have an opposite effect to that of regular stock splits. In this case, instead of increasing the number of shares outstanding, a company reduces them. This raises the price of the stock per share and makes it more attractive to fewer investors with greater capital.

In most cases, a company issues a stock split when it is confident that its stock price is likely to rise over time, benefiting investors. However, stock splits are not always beneficial, especially in situations where the company’s financial outlook is less than favorable. In this case, splitting the stock may create an illusion that it is performing better and distract from the fundamental issues at play.

In conclusion, it is important for investors to understand the reason behind a stock split and not be too influenced by the short-term gains that may follow, as the long-term performance of the stock largely depends on the underlying fundamentals. It is also essential to keep in mind that stock splits alone are not necessarily an indication of a company’s future performance.