When a company is concerned that its share price is too high or too low, it can opt for a stock split or a reverse stock split. A stock split is undertaken to decrease the share price, making the stock more accessible and attractive to potential new investors.
Conversely, a reverse stock split increases the share price, which can be particularly important for maintaining the company’s listing on major exchanges like the Australian Securities Exchange (ASX).
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What Is a Stock Split?
A stock split occurs when a company’s board of directors decides to issue more shares to its current shareholders without diluting the value of their stakes. A stock split increases the number of shares outstanding and reduces the price of each individual share. While the number of outstanding shares changes, the company’s overall market capitalisation and the value of each shareholder’s stake remain the same.
For example, if you own one share of a company’s stock and the company executes a two-for-one stock split, you would receive an additional share. However, the value of each share would now be half of what the original share was worth prior to the split. Consequently, the total value of your holdings, now two shares, would be equivalent to the value of the original share.
What Is a Reverse Stock Split?
A reverse stock split reduces a company’s number of shares outstanding. If you owned 10 shares of stock in a company, for example, and the board announced a one-for-two reverse stock split, you’d end up with five shares of stock. The total value of your shares would remain consistent. 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 either case, the total value of your investment remains $40.
Why Do Companies Split Their Stock?
In many cases, a stock split is a strategy used by companies to meet a specific goal, says Amanda Holden, a former investment counsellor and the founder of Invested Development, a course aimed at helping women learn about investing.
Companies often like the idea of creating more liquidity by making a price more attractive and attainable for a larger number of people. “You might not be able to buy Apple at $500, but you could buy it at $125,” she says.
On the other hand, a reverse stock split is often aimed at helping a company meet the minimum requirements to remain listed on an exchange.
“You can get kicked off an exchange if your price drops too far,” Holden says. “A reverse stock split consolidates your shares in a way that results in a higher per-share price that can keep you trading on a public and accessible exchange.”
This helps ensure more people can access the shares and keeps existing shares liquid. While a reverse stock split is often thought of as a red flag for investors, in the long run, it can help a company survive and recover from a rough patch.
What Is a Two-For-One Stock Split?
A two-for-one stock split grants you two shares for every one share of a company you own. If you had 100 shares of a company that has decided to split its stock, you’d end up with 200 shares after the split.
A two-for-one stock split doubles the number of shares you own instantly. Further, a two-for-one and three-for-one stock splits are relatively common, says Holden. While Apple (AAPL) and Tesla (TSLA) have gotten a lot of publicity for their 2020 stock splits, their 5-for-1 or 4-for-1 stock splits were uncommon choices.
How Does a Stock Split Affect You?
Because a stock split doesn’t change the underlying value of your investment, you may not notice any more substantial changes than the number of shares in your investment account.
“There’s no particular advantage for those who already have shares,” Holden says. “Nothing about ownership is going to change. You might have twice as many shares, but they are at half the price, so it balances out.”
For those who aren’t already shareholders, though, a stock split can provide motivation to buy. For example, if you couldn’t afford a share of Tesla before its recent stock split, you might be able to purchase one now.
The ability for more people to buy a stock can bump up its price, which in turn may actually increase a company’s value, at least temporarily, Holden says.
“With more people able to buy, you see more demand, and the price can go up. If you have more shares, this can be beneficial to you if you hold on,” Holden says. “However, that stock and total value bump is generally temporary. To see long-term gains, you usually need to keep holding that stock to get the benefit over time.”
The Bottom Line
In the end, a stock split—or even a reverse stock split—doesn’t have a huge practical impact on a company’s current investors. A stock split’s biggest impact is on investors who might be watching a particular stock and hoping to purchase a full share for a lower price. For these investors, a stock split can serve as a compelling incentive to enter the market.
Frequently Asked Questions (FAQs)
Is a split good for a stock?
A stock split can be seen as a neutral event for the stock itself in terms of value. However, it often reflects positively on the company’s performance, as it usually occurs when the share price is high. A stock split makes shares more affordable and accessible to a wider range of investors, increasing trading activity and potentially increasing the stock’s visibility in the market. However, the company’s fundamental value doesn’t change just because of a split.
Should I buy before or after a stock split?
Deciding whether to buy a stock before or after a split depends on your investment strategy and the stock’s fundamentals. Buying before a split might mean purchasing at a higher per-share price, but you’ll own more shares after the split. Buying after a split could be more affordable, with the potential for the stock to appreciate. It’s important to evaluate the company’s overall health and potential for growth rather than basing the decision solely on the split event.
What happens when stocks split?
When a stock splits, the company increases the number of its outstanding shares by issuing more shares to current shareholders. This doesn’t change the company’s overall value; instead, it divides the existing value across more shares, therefore reducing the price of each individual share. For example, in a two-for-one split, each share is split into two, and the price per share is halved. This makes the shares more affordable and appealing to a broader range of investors.
What is stock split in simple words?
A stock split is like cutting a pizza into more slices. Just as the pizza doesn’t get bigger when you cut it into more pieces, a stock split doesn’t change a company’s overall size or value. It simply divides the company’s existing shares into a larger number of shares, making each share less expensive. This can make the shares more accessible to more investors, even though the total value of all the shares combined remains the same.
