What Is A Stock Split Why Do Companies Split Their Stock

What Is a Stock Split? Why Do Companies Split Their Stock?

When a company finds its share price either too high or too low, it can choose to perform a stock split or a reverse stock split. A stock split can lower a company’s share price, making it more appealing to new investors, while a reverse stock split can increase the share price, helping the company maintain its listing on major stock exchanges.

What Is a Stock Split?

A stock split occurs when a company’s board of directors issues additional shares to current shareholders without changing the total value of their holdings. This increases the number of shares outstanding and reduces the price of each share. The market capitalization of the company and the value of each shareholder’s stake remain unchanged.

For example, if you own one share of a company’s stock and the company decides on a 2-for-1 stock split, you will receive an additional share, but each share will be worth half of the original value. After the split, your two shares will be worth the same as your original one share.

What Is a Reverse Stock Split?

A reverse stock split decreases the number of shares outstanding. If you own 10 shares and the company announces a 1-for-2 reverse stock split, you will end up with five shares. The total value of your shares remains the same. If the 10 shares were valued at $4 per share before the reverse split, the five shares would be valued at $8 per share after the reverse split. In both scenarios, the total value of your investment stays at $40.

Why Do Companies Split Their Stock?

Companies often split their stock to achieve specific goals. A stock split can create more liquidity by making the stock price more attractive and attainable for a broader range of investors. For instance, you might not be able to buy Apple at $500 per share, but you could buy it at $125 after a split.

Conversely, a reverse stock split is typically used to meet the minimum requirements for staying listed on an exchange. If a company’s share price drops too low, a reverse stock split can consolidate shares and raise the per-share price, helping the company remain listed on a public exchange. This ensures better access to shares and maintains liquidity. Although a reverse stock split can be seen as a warning sign, it can help a company survive and recover from difficult times in the long run.

What Is a 2-for-1 Stock Split?

A 2-for-1 stock split means that for every one share you own, you receive an additional share. If you have 100 shares and the company decides to split its stock, you would end up with 200 shares after the split. This doubles the number of shares you own instantly. Two-for-one and 3-for-1 stock splits are common, while 5-for-1 or 4-for-1 splits, like those done by Apple and Tesla in 2020, are less typical.

How Does a Stock Split Affect You?

Since a stock split doesn’t alter the underlying value of your investment, the most noticeable change is the number of shares in your account. You might have twice as many shares at half the price, so the total value remains the same.

For new investors, a stock split can be an incentive to buy. If you couldn’t afford a share of Tesla before its split, you might be able to buy one afterward. This increased ability to purchase shares can drive up demand and potentially increase the company’s value, at least temporarily. Long-term gains typically require holding onto the stock over time.

Are Stock Splits Important with Widespread Fractional Share Investing?

With the rise of fractional investing, stock splits might become less critical since fractional shares allow investments at nearly any price point. Platforms like Robinhood, Stash, M1 Finance, SoFi Invest, and traditional brokerages like Charles Schwab and Fidelity enable clients to buy fractional shares of stocks and ETFs.

However, the impact of fractional investing on stock splits remains to be seen. Psychological factors also play a role; many investors prefer to buy full shares, and stock splits can provide that opportunity.

The Bottom Line

Ultimately, a stock split or reverse stock split has minimal practical impact on a company’s current investors. The primary effect of a stock split is to motivate potential investors who want to buy shares at a lower price. For these investors, a stock split can be a powerful incentive to take action.