What Is a Stock Split?
A stock split happens when a company's board of directors divides its stock in order to increase total number of shares outstanding. When this happens, a single share reduces in market value as it now represents a smaller portion of ownership in the company.
A lower share price can seem more appealing to investors. Many investors may feel intimidated by a $2,000 share price, but a $20 share price is far more appealing. Therefore, corporations tend to be more likely to split their stock when the share price is quite high.
While a corporation's market capitalization does not change as a result of a stock split directly, in many cases the company's valuation will trend as a result of new investors buying into the lower share price.
Another key advantage of a stock split is that it can help boost liquidity since the difference between a stock’s bidding and asking prices will be smaller. The bidding price is the amount buyers offer to pay for a stock while the asking price is that which the seller is offering the stock. If a stock trades at $1,000 per share, the difference between the bidding and asking price is likely large when compared to a stock which trades at $10 a share.
Key Takeaway: In the event of a stock split, the corporation's market capitalization does not change directly, but may trend higher as new investors take positions at the lower share price.
What Happens When a Stock Splits?
In a 2-for-1 stock split, an additional share is given for every share currently owned by a stockholder. For instance, if a company has 50 million shares before the split, it will have 100 million shares following the stock split. As a result, each share loses half of its ownership value. But since the number of outstanding shares has doubled, it won’t affect the total value of an investor's position.
Key Takeaway: The reduced stock price following a stock split makes a highly desirable company's shares appear more reasonable to more people.
Motivations for doing this usually stem from a corporation’s acknowledgement that its stock has soared so high and for quite some time, which in turn can limit its access to fresh capital. In this scenario, the corporation understands the benefits of a stock split exceed the downsides of lowering the value of each share.
Why Do Stocks Split?
Stock splits make shares more affordable to more people, and companies may benefit as a result. Although the price per share drops in a stock split, and the number of shares outstanding increases, as stated earlier, the stock split has no direct impact on the market capitalization of a company.
When Do Stocks Split?
Stock splits may occur when a stock price is high and the company wants to make its shares more attractive to everyday investors, making them more easily tradable, thus increasing liquidity. A company may also decide to carry out a reverse stock split when its stock price is so low that it risks becoming delisted.
Types of Stock Splits
2-for-1 stock splits are quite common, but stock splits can occur in any ratio. Common types/ratios include:
In the case of a 3-for-2 stock split, the company issues three new shares for every two shares you own. One way to find your new share total is to:
multiply your old share by 3/2 or 1.5
For instance, if you had 300 shares before the 3-for-2 stock split, you now have 450 shares.
In the case of a 4-for-1 stock split, the 300 shares you originally had will now total 1,200, and so on.
How Do Stock Splits Affect EPS?Earnings per share (EPS) and other per-share metrics will be affected by stock splits. If a company was earning $10/share prior to a 4-for-1 stock split, the earnings will represent only $2.50 per share afterwards. Remember though that stock splits also result in a lower share price, so valuation multiples won't be directly impacted.
What Is a Reverse Stock Split?
A reverse stock split is the opposite of a regular stock split. Instead of increasing the number of shares outstanding, a reverse stock split will decrease the share count. For example, in a 1-for-2 reverse stock split, every 2 shares previously held become only 1 share.
All the dynamics of a reverse stock split are opposite. The share price will increase, while EPS and other per-share metrics will increase, since there are less shares outstanding than before.
Quite commonly companies will consider reverse stock splits if the trading price of their shares is very low. Some stock exchanges require a minimum share price as a listing requirement, so some companies may face the prospect of a delisting unless they complete a reverse stock split (or are able to boost their share price through some other means). One word of warning, however. Often stocks do not perform well following reverse stock splits.
Key Takeaway: Stocks often underperform after they've conducted a reverse stock split.
Noteworthy Stock Splits in History
Amazon Stock Split: May 2022
Amazon (AMZN) announced on March 9, 2022, its first stock split since the dot-com bubble of 1999. The AMZN stock split date is May 25, 2022. The board of directors approved a 20-1 split, which means that shareholders will own 20 shares for every one share owned prior to the split.
The board also authorized a stock buyback of up to $10 billion of shares. Companies buy back shares for various reasons, including consolidation of ownership and to increase the value of shares.
Alphabet Stock Split: July 2022
Alphabet (GOOG) (GOOGL) announced a 20-1 stock split in the form of a one-time special stock dividend, effective for its Class A, Class B, and Class C shares. The Google stock split date is July 1, 2022. If the stock split is approved, shareholders will own 20 shares for every one share owned prior to the split.
As of April 1, 2022, GOOG stock was trading at $2814.00 per share. The 20-1 split would make the price $140.70. Like Amazon, Alphabet is planning stock buybacks, which can be more easily accommodated after stock splits.
Apple Stock Split: August 2020
Apple (AAPL) is one of the most desirable stocks around. But at its top asking price, at times, it can turn off some investors. That’s why on August 31, 2020, Apple decided to split its stock 4-for-1, meaning investors who owned one share suddenly owned four. Prior to the stock split, one share of Apple cost nearly $500, but after the split, shares dropped to ~$125 a piece.
This was by no means the first time Apple split its stock price. In fact, this marked the fifth time the Silicon Valley firm carried out a stock split since its IPO in 1980. In one of its previous stock splits, Apple split its stock 7-for-1, lowering its share price from $650 a piece to under $100.
Tesla Stock Split: August 2020
Tesla (TSLA) is another hot stock which instantly became more accessible to a wider array of investors following its stock split. For instance, in August 2020, Tesla split its stock 5-for-1. Before the split, a single share of Tesla cost $2,213; but afterwards it was approximately $440.
Is A Stock Split Good Or Bad?
Although a stock split does not alter a corporation's valuation directly, investors usually take the news of a stock split favorably. Stock split announcements tend to signal that a company's board is confident, and may be trying to appeal to investors with a lower share price. If the stock split is successful, and the firm can attract a new wave of investment, the stock’s value will often rise.
Advantages of a Stock Split
A stock split can be greatly beneficial to investors.
- Some studies suggest that stocks which have split tend to outperform the broader market in the immediate years following a split.
- When each share price is lower, it becomes easier to sell shares once an investor decides to buy new ones on the market.
- Each trade involves a smaller percentage of an investor’s overall portfolio, which can offer more flexibility.
Disadvantages of a Stock Split
- Has the potential to create volatility
- Not all stock splits increase a share price in the long run. The long-term value of the business is the ultimate determinant.
Is It Better To Buy A Stock Before Or After A Split?
With all this in mind, one might argue that it is advantageous for an investor to buy a stock before a stock split. That way, the shareholder owns shares prior to the arrival of a new wave of investors, who in turn, if things go according to the board’s initial aim, bring in a fresh round of cash and help build the stock's appreciation.