Understanding Stock Splits (2024)

All publicly traded companies have a set number of shares that are outstanding. A stock split is a decision by acompany's board of directors to increase the number of shares outstanding by issuing more shares to current shareholders.

For example, in a 2-for-1 stock split, a shareholder receives an additional share for each share held. So, if a company had 10 million shares outstanding before the split, it will have 20 million shares outstanding after a 2-for-1 split.

A stock's price is also affected by a stock split. After a split, the stock price will be reduced (because the number of shares outstanding has increased). In the example of a 2-for-1 split, the share price will be halved. Thus, while a stock split increases the number of outstanding shares and proportionally lowers the share price, the company's market capitalization remains unchanged.

Key Takeaways

A stock split is a corporate action in which a company increases the number of its outstanding shares by issuing more shares to current shareholders.

  • Stock splits can improve trading liquidity and make the stock seem more affordable.
  • In a stock split the number of outstanding shares increases and the price per share decreases proportionately, while the market capitalization and the value of the company do not change.
  • The most common split ratios are 2-for-1 and 3-for-1, which means that a stockholder will have two or three shares, respectively, for every share held before the split.
  • Reverse stock splits are when a company reduces the number of shares outstanding, thereby raising the market price of each share.

Why Do Companies Engage in Stock Splits?

When a company's share price increases to a nominal level that may make some investors uncomfortable, or is beyond the share prices of similar companies in the same sector, the company's board may decide on a stock split. A stock split can make the shares seem more affordable, even though the underlying value of the company has not changed.It can also increase the stock's liquidity.

When a stock splits, it can also result in a shareprice increase—even though there may be a decrease immediately after the stock split. This is because small investors may perceive the stock as more affordable and buy the stock. This effectively boosts demand for the stock and drives up prices. Another possible reason for the price increase is that a stock split provides a signal to the market that the company's share price has been increasing; people may assume this growth will continue in the future. This further lifts demand and prices.

In June 2014, Apple Inc.split its shares seven-for-one in order to make its shares more accessible to a larger number of investors. Right before the split, each share's opening price was approximately $649.88. After the split, the price per share at market open was $92.70 (648.90 / 7).

Existing shareholders were also given six additional shares for each share they owned prior to the stock split. So, an investor who owned 1,000 shares of AAPL before the stock split had 7,000 shares after the stock split. Apple's outstanding shares increased from 861 million to 6 billion shares. However, the market capitalization of the company remained largely unchanged at $556 billion. The day after the stock split, the price had increased to a high of $95.05 to reflect the increased demand from the lower stock price.

What Is a Reverse Stock Split?

Another version of a stock split is called a reverse split. This procedure is typically used by companies with low share prices that would like to increase their prices. A company may do this if they are afraid their shares are going to be delisted or as a way of gaining more respectability in the market. Many stock exchanges will delist stocks if they fall below a certain price per share.

For example, in a reverse one-for-five split, 10 million outstanding shares at $0.50 cents each would now become 2 million shares outstanding at $2.50 per share. In both cases, the company is still worth $5 million.

In May 2011, Citigroupreversesplit its shares one-for-10 in an effort to reduce its share volatility and discourage speculator trading. The reverse split increased its share price from $4.52 to $45.12 post-split. Every 10 shares held by an investor were replaced with one share. Though the split reduced the number of its shares outstanding from 29 billion to 2.9 billion shares, the market capitalization of the company stayed the same (at approximately $131 billion).

If the math doesn't work out evenly when effecting a reverse split (for example, you have five shares and there is a two-for-three reverse split), you may receive fractional shares (7.5 in this case), and in some instances may receive cash in the amount of a rounding error, or if fractional shares are unavailable. This is known as cash in lieu (CIL). For tax purposes, CIL is treated as a sale of shares.

How Do Stock Splits Affect Short Sellers?

Stock splitsdo not affectshort sellersin a material way. There are some changes that occur as the result of a split that can impact the short position. However, they don't affect the value of theshort position. The biggest change that happens in the portfolio is the number of shares shorted and the price per share.

When an investor shorts a stock, they are borrowing the shares with the agreement that they will return them at some point in the future. For example, if an investor shorts 100 shares ofXYZCorp. at $25, they will be required to return 100 shares of XYZ to the lender at some point in the future. If the stock undergoes a two-for-one split before the shares are returned, it simply means that the number of shares in the market will double along with the number of shares that need to be returned.

When a company splits its shares, the value of the shares also splits. For example, suppose the shares of XYZ Corp. were trading at $20 at the time of the two-for-one split; after the split, the number of shares doubles, and the shares trade at $10 instead of $20. If an investor has 100 shares at $20 for a total of $2,000, after the split, they will have 200 shares at $10 for a total of $2,000.

In the case of a short investor, prior to the split, they owe 100 shares to the lender. After the split, they will owe 200 shares (that are valued at a reduced price). If the short investor closes the position right after the split, they will buy 200 shares in the market for $10 and return them to the lender.

The short investor will have made a profit of $500 (money received at short sale: $25 x 100) minus the cost of closing out short position ($10 x 200). That is, $2,500 - $2,000 = $500. The entry price for the short was 100 shares at $25, which is equivalent to 200 shares at $12.50. So the short made $2.50 per share on the 200 shares borrowed, or $5 per share on 100 shares if they had sold before the split.

The Bottom Line

A stock split is used primarily by companies that have seen their share prices increase substantially. Although the number of outstanding shares increases and the price per share decreases, the market capitalization (and the value of the company) does not change. As a result, stock splits help make shares more affordable to smaller investors and providesgreater marketability and liquidity in the market.

Understanding Stock Splits (2024)

FAQs

Understanding Stock Splits? ›

In a stock split, a company divides its existing stock into multiple shares to boost liquidity. Companies may also do stock splits to make share prices more attractive. For shareholders, the total dollar value of their investment remains the same because the split doesn't add real value.

Is it better to buy before or after a stock split? ›

Does it matter to buy before or after a stock split? If you buy a stock before it splits, you'll pay more per share than what it'll cost after it splits. If you're looking to buy into a stock at a cheaper price, you may want to wait until after the stock split.

What does a 1 to 4 stock split mean? ›

For example, a 1-to-4 (or 1:4) reverse stock split means that a person with 4 shares now has 1, and each of those shares are now worth 4 times the previous value. In a 1-to-3 reverse stock split, a person with 3 shares now has 1 share. Subsequently, each of those shares is now worth 3 times the previous value.

What is a good stock split ratio? ›

While a 2:1 stock split is the most common, any other ratio may be used so long as it is approved by the company's board of directors and, in some cases, by shareholders. Split ratios may be, for instance, 3:1, 10:1, 3:2, etc. In the last case, if you owned 100 shares you would receive 50 additional shares post-split.

What does a 3-for-2 stock split mean? ›

A 3-for-2 split means the investor will have one and one half times as many shares as the investor had before the split, with each share having a value of two-thirds of the pre-split market price.

Do stocks normally go up after a split? ›

A stock split doesn't change the value of your investment. If you own the stock of a company that executes a stock split, the details of your position change, but the total value of your position does not. Here are the key things to know about stock splits.

What are the disadvantages of a stock split? ›

Disadvantages of a Stock Split

A company cannot rely on a stock split to increase its value or market cap. A stock split divides the existing shares, thus keeping the market cap the same as before. Not to forget, a company must invest some amount to conduct a stock split.

Are stock splits good for investors? ›

It's basically a draw, and the value of your investment won't change. However, investors generally react positively to stock splits, partly because these announcements signal that a company's board wants to attract investors by making the price more affordable and increasing the number of shares available.

Which stock is splitting in 2024? ›

Walmart's common stock will begin trading on a post-split basis at the market open on Monday, Feb. 26, 2024, under the company's existing trading symbol “WMT.” The stock split and final ratio were approved by Walmart's board.

Is a reverse split good? ›

Many times reverse splits are viewed negatively, as they signal that a company's share price has declined significantly, possibly putting it at risk of being delisted. The higher-priced shares following the split may also be less attractive to certain retail investors who prefer stocks with lower sticker prices.

What's a reverse split in stocks? ›

Reverse stock splits work the same way as regular stock splits but in reverse. A reverse split takes multiple shares from investors and replaces them with fewer shares. The new share price is proportionally higher, leaving the total market value of the company unchanged.

Why is Chipotle stock so high? ›

Key Points. Chipotle's fresh approach to fast casual dining is still drawing crowds. The stock has gained 68% over the past year, and management recently announced a major stock split. Improved throughput, a robust rewards program, and higher purchase frequency should continue to drive growth.

How many times has Amazon stock split? ›

Amazon (NASDAQ: AMZN) has had four stock splits since its initial public offering in 1997, with its most recent one occurring in June 2022 in a 20-to-one split. The company has enjoyed immense success over the years by leading two crucial sectors: e-commerce and cloud computing.

Should I sell before a stock split? ›

That said, many stocks have shown strong performance after a split. In other words, selling your shares of a stock prior to a split isn't always the best decision – unless, of course, you're not well-positioned to continue holding the stock.

What is the difference between a stock dividend and a stock split? ›

Stock dividend means distribution of additional shares of own stock to stockholder without any payment in return. Stock split is the distribution of additional shares more than one new share in exchange for each one existing share.

Why stock splits are good? ›

However, stock splits often do lead to portfolio growth. With a forward split, the biggest advantage is that your shares can gain value more quickly. New investors can buy in more easily, allowing for faster potential growth in the company's share price.

Should I buy Google stock before the split? ›

Any decision you make — buy, hold or sell — is not likely to have a much different outcome if you make it just before or just after the split. Since a stock split is announced prior to being executed, any post-split bump that the market expects is baked into the price by the time the split actually occurs.

What stocks are expected to split in 2024? ›

3 Potential Stock Splits to Add to Your 2024 Radar
  • Broadcom (NASDAQ:AVGO) is the most expensive stock on this list on a per-share basis. ...
  • Deckers Outdoor (NYSE:DECK) is another that needs a stock split. ...
  • Nvidia (NASDAQ:NVDA) is no stranger to the spotlight after gaining almost 2,000% over the past five years.
Mar 20, 2024

What does a 5 for 1 stock split mean? ›

If they say 5 for 1 then that is done to reduce the price of the stock by issuing five shares for every one share currently available. This is a good type of split.

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