Stock splits are on everyone’s radar since the parent company of the search engine Google, Alphabet (GOOG), announced plans for a 20-for-1 stock split on February 1, 2022. If approved by Alphabet’s stockholders, this stock split will take effect on Friday, July 15. As a result, stockholders will receive 19 additional shares for each share of Alphabet stock they own. Then, when the markets open on Monday, July 18, Alphabet will begin trading under its new price. This split is not the first time Alphabet had a stock split. The company had a 2-for-1 split in 2014.
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What is a Stock Split?
A stock split sometimes called a one-time specialstock dividend, is when a company issues additional shares of its stock to existing shareholders. This action increases the number of its shares by a specific multiple and simultaneously reduces the price of each share. Although the number of shares increases, the total dollar amount of all shares, the market capitalization, stays the same. Each share would be individually worth a smaller amount.
The company’s net value as measured bymarket capitalization, the value of a publicly-traded company, is calculated by multiplying the current share price by the total number of shares. The total value of a company does not change with a stock split. Investors would retain the full value of their pre-split shares. Shareholders would own more shares but at the lower split price.
For example, if a stockholder owned 100 shares of Company XYZ at $100 per share, they would possess $10,000 worth of stock. If Company XYZ underwent a 2-for-1 stock split, the investor would have 200 shares at $50 per share. Their total stock value is still $10,000.
Common Ratios
A company’s board of directors determines the ratio of a stock split. However, it must often be approved by the shareholders. According toInvestopedia.com, the most common split ratios are 2-for-1 or 3-for-1. Other common ratios are 3-for-2, 5-for-4, 4-for-1, and 5 for-1. The 20-for-1 stock split Alphabet (GOOG) has recentlyannouncedis not common.
In a real-world example, Apple (APPL) split its stock at a 4-for-1 ratio on Monday, August 30, 2021. The stock price was $499.23 per share before and approximately $127 per share after the split. In another example, Tesla split its stock at a 5-for-1 ratio on Monday, August 31, 2020. The stock price was $2,213 each before the split and about $442 per share after the split.
Why do Companies Stock Split?
Liquidity
Stock splits are usually conducted to increase the liquidity of a company. According toInvestor.gov, stock liquidity refers to how quickly a stock can be bought or sold without impacting the stock’s price. Liquidity makes it easier for buyers and sellers to trade the stock.
In addition, stock splits make a high-priced stock more affordable to many people. It appeals primarily to new investors who may not have been able to afford the stock before the split. New investors may purchase a coveted stock due to the opportunity to buy shares at a lower price.
For example, on Friday, February 4, Alphabet’s Class A stock’s closing price on the NASDAQ was $2865.86. If the 20-for-1 stock split were to hypothetically take place that day, on Monday, February 7, the share price would be $143.29. The split share price would be much more affordable for the average investor! However, before and after the split, the market capitalization would remain at $1.8 trillion. Although now, more new investors can afford the stock price.
High Priced Stock Are Unaffordable
A stock with a high price per share is often unaffordable for average retail investors. For instance, the class A shares of Warren Buffett’s Berkshire Hathaway (BRK.A) are trading at about $474,900 per share. Few investors can afford a single share. Buffett eventually issued Class B shares (BRK.B) to solve the problem. These shares were valued at 1/30th of the Class A shares. The shares were split at a 50-for-1 ratio when Berkshire Hathaway acquitted Burlington Northern Santa Fe railroad. If this split was not conducted, the Class B shares would also be unaffordable for most retail investors.
Other Benefits
Inaddition, other benefits include reducing the ask and buy spreads and intraday volatility but increasing dollar volume.
Do Stock Splits Make a Company More Valuable?
In theory, a stock split does not add or take away value from a company’s value. The number of shares increases, but the price of each one is less. The company has the same market capitalization before and after the stock split. Even dividend payments are adjusted to reflect the new share totals and pricing when paid out to investors.
However, when companies split stocks, it can create renewed interest in the company with the press and investors. This interest can help increase the stock price. In addition, stock splits are seen as a positive signal because they result from new and potential growth. This point, too, also helps attract new investors.
Research Shows Excess Returns
Although the company is not more valuable, someresearchhas shown stocks that split generally outperform the broader market. For example, aNasdaq studydemonstrated that just announcing a stock split caused a 2.5% increase in the stock price, which was about 5% higher one year later. Anotherstudy from Cambridge Universityshowed an excess return of almost 8% in 1-year and around 12% in 3-years after a 2-for-1 stock split.
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What Are Reverse Stock Splits?
Reverse stock splits are the opposite of forward ones. In this case, investors receive fewer shares than they previously held. For example, in a 1-for-10 reverse stock split, a stockholder with 10,000 shares would end up with 1,000 shares at a higher price per share. However, the company’s market capitalization is still the same before and after the reverse stock split.
A reverse stock split is usually viewed negatively by investors. It is often done to prevent a company from being delisted for too low a share price.
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Christine Seaver
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Christine Seaver is a freelance writer that writes about personal finance, budgeting, and debt. She is a frequent contributor at Dividendpower.org. Christine works as an office manager by day and a cookie baker at night. She lives in Massachusetts with her family.
As an enthusiast well-versed in the realm of finance and stock markets, I'm here to delve into the intriguing world of stock splits and provide a comprehensive understanding of the concepts used in the article. My expertise draws from a deep knowledge of financial markets, investment strategies, and a keen eye for analyzing corporate actions.
Let's break down the key concepts used in the article:
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Alphabet's (GOOG) 20-for-1 Stock Split:
- Alphabet, the parent company of Google, has announced a 20-for-1 stock split scheduled for July 15, 2022.
- Stockholders will receive 19 additional shares for each share they currently own.
- The market capitalization remains the same, but the price per share decreases, making it more affordable.
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What is a Stock Split?
- A stock split is when a company issues additional shares to existing shareholders, increasing the total number of shares and decreasing the price per share.
- Market capitalization (total company value) remains unchanged despite the increase in shares.
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Common Ratios:
- Stock splits are typically executed at common ratios such as 2-for-1, 3-for-1, 3-for-2, 5-for-4, 4-for-1, and 5-for-1.
- Alphabet's 20-for-1 stock split is relatively uncommon.
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Why do Companies Stock Split?
- Liquidity: Stock splits aim to increase stock liquidity, making it easier for stocks to be bought or sold without significant impact on the stock price.
- Affordability: High-priced stocks become more accessible to a broader range of investors.
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Common Benefits and Effects:
- Reduced ask and buy spreads, decreased intraday volatility, and increased dollar volume are additional benefits of stock splits.
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Does a Stock Split Make a Company More Valuable?
- In theory, a stock split doesn't change the company's overall value. Market capitalization remains constant.
- However, stock splits can generate renewed interest in a company, potentially leading to increased stock prices.
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Research on Stock Splits:
- Studies suggest that stocks undergoing splits tend to outperform the broader market.
- Announcing a stock split alone can lead to an increase in stock prices, and one year later, the outperformance may be even more significant.
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Reverse Stock Splits:
- Reverse stock splits involve investors receiving fewer shares at a higher price per share.
- They are often viewed negatively and may be done to prevent delisting due to a low share price.
In conclusion, stock splits play a crucial role in enhancing liquidity, making stocks more accessible, and potentially generating positive market responses. While they don't inherently change a company's value, the psychological and practical effects can be substantial, influencing investor behavior and market dynamics.
