What a Stock Split Is and How It Works, With an Example (2024)

What Is a Stock Split?

A stock split happens when a company increases the number of its shares to boost the stock's liquidity. Although the number of shares outstanding increases by a specific multiple, the total dollar value of all shares outstanding remains the same because a split does not fundamentally change the company's value.

The most common split ratios are 2-for-1 or 3-for-1 (sometimes denoted as 2:1 or 3:1). This means for every share held before the split, each stockholder will have two or three shares, respectively, after the split.

Key Takeaways

  • A stock split is when a company increases the number of its outstanding shares to boost the stock's liquidity.
  • Although the number of shares outstanding increases, there is no change to the company's total market capitalization as the price of each share will split as well.
  • The most common split ratios are 2-for-1 or 3-for-1, which means every single share before the split will turn into multiple shares after the split.
  • A company elects to perform a stock split to intentionally lower the price of a single share, making the company's stock more affordable without losing value.
  • Reverse stock splits are the opposite transaction, in which a company lowers, instead of increasing, the number of shares outstanding, raising the share price accordingly.

How a Stock Split Works

A stock split is a corporate action in which a company issues additional shares to shareholders, increasing the total by the specified ratio based on the shares they held previously. Companies often choose to split their stock to lower its trading price to a more comfortable range for most investors and to increase the liquidity of trading in its shares.

Most investors are more comfortable purchasing, say, 100 shares of a $10 stock as opposed to 1 share of a $1,000 stock. So when the share price has risen substantially, many public companies end up declaring a stock split to reduce it. Although the number of shares outstanding increases in a stock split, the total dollar value of the shares remains the same compared with pre-split amounts, because the split does not make the company more valuable.

A company's board of directors can choose to split the stock by any ratio. For example, a stock split may be 2-for-1, 3-for-1, 5-for-1, 10-for-1, 100-for-1, etc. A 3-for-1 stock split means that for every one share held by an investor, there will now be three. In other words, the number of outstanding shares in the market will triple.

On the other hand, the price per share after the 3-for-1 stock split will be reduced by dividing the old share price by 3. That's because a stock split does not alter the company's value as measured by market capitalization.

Special Considerations

Market capitalization is calculated by multiplying the total number of shares outstanding by the price per share. For example, assume XYZ Corp. has 20 million shares outstanding and the shares are trading at $100. Its market cap will be 20 million shares x $100 = $2 billion.

Let's say the company’s board of directors decides to split the stock 2-for-1. Right after the split takes effect, the number of shares outstanding would double to 40 million, while the share price would be halved to $50. Although both the number of shares outstanding and the market price have changed, the company's market cap remains unchanged at (40 million shares x $50) $2 billion.

In the U.K., a stock split is referred to as a scrip issue, bonus issue, capitalization issue, or free issue.

Advantages of a Stock Split

Why do companies go through the hassle and expense of a stock split? First, a company often decides on a split when the stock price is quite high, making it expensive for investors to acquire a standard board lot of 100 shares.

Second, the higher number of shares outstanding can result in greater liquidity for the stock, which facilitates trading and may narrow the bid-ask spread. Increasing the liquidity of a stock makes trading in the stock easier for buyers and sellers. This can help companies repurchase their shares at a lower cost since their orders will have less of an impact on a more liquid security.

While a split, in theory, should have no effect on a stock's price, it often results in renewed investor interest, which can have a positive effect on the stock price. While this effect may wane over time, stock splits by blue-chip companies are a bullish signal for investors. A stock split may be viewed by some as a company wanting a bigger future runway for growth; for this reason, a stock split generally indicates executive-level confidence in the prospect of a company.

Many of the best companies routinely see their share price return to levels at which they previously split the stock, leading to another stock split. Walmart, for instance, split its stock 11 times on a 2-for-1 basis between the retailer's stock-market debut in October 1970 and March 1999. An investor who bought 100 shares in Walmart’s initial public offering (IPO) would have seen that stake grow to 204,800 shares over the next 30 years without any additional purchases.

Disadvantages of a Stock Split

Not all facets of a stock split benefit a company. The process of a stock split is expensive, requires legal oversight, and must be performed in accordance with regulatory laws. The company wanting to split their stock must pay a great deal to have no movement in its over market capitalization value.

A stock split isn't worthless, but it doesn't impact the fundamental position of a company and therefore doesn't create additional value. Some compare a stock split to cutting a piece of cake. If the dessert tastes horrible, it doesn't matter whether it has been cut into 10 pieces or 20 pieces.

Some opponents of stock splits view the action as having the potential to attract the wrong crowd of investors. Consider Berkshire Hathaway's Class A shares trading for hundreds of thousands of dollars. Had Warren Buffet split the stock, many traders in the general public would be able to afford his company's shares. Instead, to maintain equity ownership as exclusive, a company may want to intentionally not split its shares.

Last, there are implications for intentionally reducing the company's share price. Public exchanges such as the NASDAQ require stock to trade at or above $1. Should a share price drop below $1 for thirty consecutive days, the company will be issued a compliance warning and will have 180 days to regain compliance. Should the company's stock price still not meet minimum pricing requirements, the company risks being delisted.

Example of a Stock Split

In August 2020, Apple (AAPL)split its shares 4-for-1. Right before the split, each share was trading at around $540. After the split, the price per share at the market open was $135 (approximately $540 ÷ 4).

An investor who owned 1,000 shares of the stock pre-split would have owned 4,000 shares post-split. Apple's outstanding shares increased from 3.4 billion to approximately 13.6 billion, while the market capitalization remained largely unchanged at $2 trillion.

A company may choose to split its stock as many times as it would like. For instance, Apple also split its stock 7-for-1 in 2014, 2-for 1 in 2005, 2-for-1 in 2000, and 2-for-1 in 1987.

To convert a quantity of pre-split shares to post-split shares across multiple splits, multiple the ratio value of each split together. For example, a single pre-split share in 1987 would have eventually been split into 224 shares after the 2020 split. This is determined by multiplying 4, 7, 2, 2, and 2.

Stock Splits vs. Reverse Stock Splits

A traditional stock split is also known as a forward stock split. A reverse stock split is the opposite of a forward stock split. A company carrying out a reverse stock split decreases the number of its outstanding shares and increases the share price proportionately. As with a forward stock split, the market value of the company after a reverse stock split remains the same.

A company that takes this corporate action might do so if its share price had decreased to a level at which it runs the risk of being delisted from an exchange for not meeting the minimum price required for a listing. Certain mutual funds may not invest in stocks priced below a preset minimum per share. A company might also opt for a reverse split to make its stock more appealing to investors who may perceive higher-priced shares as more valuable.

A reverse/forward stock split is a specialstock splitstrategy used by companies to eliminate shareholders holding less than a certain number of shares. A reverse/forward stock split consists of areverse stock splitfollowed by a forward stock split. The reverse split reduces the overall number of shares a shareholder owns, causing some shareholders who hold less than the minimum required by the split to be cashed out. The forward stock split then increases the number of shares owned by the remaining shareholders.

What Happens if I Own Shares That Undergo a Stock Split?

When a stock splits, it credits shareholders of record with additional shares, which are reduced in price in a comparable manner. For instance, in a typical 2:1 stock split, if you owned 100 shares that were trading at $50 just before the split, you would then own 200 shares at $25 each. Your broker would handle this automatically, so there is nothing you need to do.

Will a Stock Split Affect My Taxes?

No. The receipt of the additional shares will not result in taxable income under existing U.S. law. The tax basis of each share owned after the stock split will be half of what it was before the split.

Are Stock Splits Good or Bad?

Stock splits are generally done when the stock price of a company has risen so high that it might become an impediment to new investors. Therefore, a split is often the result of growth or the prospects of future growth, and it's a positive signal. Moreover, the price of a stock that has just split may see an uptick if the lower nominal share price attracts new investors.

Does the Stock Split Make the Company More or Less Valuable?

Stock splits neither add nor subtract fundamental value. The split increases the number of shares outstanding, but the company's overall value does not change. Immediately following the split the share price will proportionately adjust downward to reflect the company's market capitalization. If a company pays dividends, the dividend per share will be adjusted accordingly, keeping overall dividend payments the same. Splits are also non-dilutive, meaning that shareholders will retain the same voting rights they had beforehand.

Can a Stock Split Be Anything Other Than 2-for-1?

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 a Stock Split Is and How It Works, With an Example (2024)

FAQs

What a Stock Split Is and How It Works, With an Example? ›

Stock splits come in multiple forms, but the most common are 2-for-1, 3-for-2 or 3-for-1 splits. For example, let's say you owned 10 shares of a stock trading at $100. In a 2-for-1 split, the company would give you two shares with a market-adjusted worth of $50 for every one share you own, leaving you with 20 shares.

What is stock split with example? ›

When a stock splits, it credits shareholders of record with additional shares, which are reduced in price in a comparable manner. For instance, in a typical 2:1 stock split, if you owned 100 shares that were trading at $50 just before the split, you would then own 200 shares at $25 each.

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.

Is a stock split good or bad? ›

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.

How does a stock split work? ›

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.

What usually happens to a stock after a split? ›

Normally, a stock split will reduce the price per share of each share in proportion to the increase in shares. Using this example, a 2-1 split for a stock trading at $200 would halve the price to $100 and double the number of total shares outstanding.

How do you benefit from a stock split? ›

It increases liquidity

Another one of the main stock split benefits is that the shares of a company generally see increased liquidity. Since shares have now become more accessible to retail investors, more people would show increased demand for it, which can increase liquidity in the counter.

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.

What does a 10 to 1 stock split mean? ›

For example, instead of a stock trading at $1,000 per share, a 10-for-1 stock split would allow it to trade for $100 per share (FIGURE 1) while the number of held shares would increase tenfold. This is also called a forward split.

Should I sell my stock 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 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

At what price do stocks usually split? ›

“A company will typically do this if a stock price is in the low single digits—such as $3 per share, or $2 per share,” says Dave Heger, senior equity analyst at Edward Jones.

Has Costco stock split? ›

Costco hasn't split its stock in a while. Its last split came in January 2000, when the stock traded for a pre-split price of about $100.

Should I sell after a stock split? ›

Splits are often a bullish sign since valuations get so high that the stock may be out of reach for smaller investors trying to stay diversified. Investors who own a stock that splits may not make a lot of money immediately, but they shouldn't sell the stock since the split is likely a positive sign.

What does a 20 to 1 stock split mean? ›

When a company splits its stock, that means it divides each existing share into multiple new shares. In a 20-1 stock split, every share of the company's stock will be split into 20 new shares, each of which would be worth one twentieth of the original share value.

What is the primary reason for declaring a stock split? ›

Therefore, the stock split is particularly useful when the stock price becomes too high for most people. It lowers the value of each stock and makes the trading price acceptable to more investors, which increases the trading volume and liquidity of the stock.

What does a 10 to 1 share split mean? ›

Let us assume that this ratio is 10:1 (or 10-for-1). The 10:1 stock split meaning is fairly intuitive; it implies that for every one share held, shareholders get ten shares (post-split).

Do stocks go up after a split? ›

From time to time, stock splits are followed by a bump in stock performance—but not always. Is the split worth it? – Stock splits have no tangible impact on a company's total value—they simply create more shares at more affordable prices.

What does a 4 to 1 stock split mean? ›

If the company had decided to do a 4-for-1 stock split, each owner of the share would have received three additional shares. The value of the new shares will be $25 each. Let's take a look at some of the major companies that have split their stock.

What does a 3 for 1 stock split mean? ›

With a three-for-one stock split, each old share becomes equal to three shares. In turn, the price per share becomes cheaper. So far this year, shares are up more than 11%, outpacing the S&P 500's nearly 7% rise. Shares are trading just below its all-time high of $181.35 per share.

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