For an investor, the assets in your portfolio may undergo changes over time. They may increase or decrease in value, and sometimes they may be impacted by what's known as a stock split.
A stock split can have various ramifications depending on the type of split that takes place. In some cases, you may end up with more shares, and in other cases with fewer. But importantly, the value of your holdings does not change.
What is a stock split?
A stock split is when a company breaks an existing share into multiple shares. In other words, one share of a particular company's stock in your portfolio may be broken into two shares, three, or even more as a result of a stock split.
Publicly traded companies periodically choose to split their stocks when share prices climb too high. Taking this step reduces the unit price of each stock.
“For example, if a company’s share price is $100, the board might decide that by splitting the shares, they can make their stock more accessible to more investors. The board could authorize a two-for-one stock split so that holders of one original share end up with two shares after the split,” says Andrew Crowell, financial adviser and vice chairman of wealth management at D.A. Davison. “If the share price was $100 before the split, the post-split shares would be $50 each.”
Stock splits allow a company to increase the liquidity of its shares—or how often the shares are traded on a stock exchange. This is also referred to as volume, which is the total number of shares traded within a particular time frame.
“A low-volume stock is not traded very frequently,” says Jon Klaff, general manager of Magnif. “The price of a stock can impact its volume, with higher prices making it more difficult to buy and sell. Most people don’t want to be stuck with a stock they can’t sell.”
The importance of stock split proportions
The exact proportion of the stock split plays a significant role in the resulting price of the individual shares. Stock splits often happen on a two-for-one basis, which means if you had one share, you now have two, as Crowell mentioned. But depending on how much the company wants to reduce its share price, there may also be three-for-one splits, four-for-one splits, and so on.
In fact, in some cases, the proportion of the split is even higher, such as 20-for-1. That was the case with Google’s parent company Alphabet, which split its stocks 20-for-1 in July, making shares significantly more affordable to retail investors. As a result of the split, Alphabet’s Class A stock prices dropped from about $2,255 per share to about $112 each, making purchases far more palatable to those looking to buy whole shares.
What are reverse stock splits?
Not all stock splits are designed to decrease share prices. In some cases, the split may be aimed at just the opposite—increasing the price per share. This is known as a reverse stock 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. “If a stock trades below a certain cutoff point, you run the risk of getting delisted, and so the company will do a reverse split.”
In a reverse split scenario, if a stock is currently $3 a share and the company engages in a 10-to-1 split, the price increases to $30 per share, and the total number of shares in your portfolio for that company decreases.
How does a stock split impact your portfolio?
When a stock splits, the overall dollar value of the holdings in your portfolio for that stock generally does not change. You simply have more—or less—stocks than you did prior to the split. But because the price of each stock has also been altered by the split, the value ends up being identical.
“For example, one share worth $100 is worth the same as two shares at $50, so it ends up being a wash,” says Heger.
Despite this fact, there’s often a perception among investors that stock splits do indeed add value—at least over the long term. This is because when a stock becomes more affordable, it may attract more investors, which may ultimately drive up the price.
“The split may trigger renewed investor interest, potentially attracting more retail shareholders into the stock who might view it as more attainable to buy,” continues Heger.
Pros and cons of stock splits
While a stock split may not change the overall value of your holdings, there are some pros and cons to these types of events.
Pro: Makes shares more affordable. Stock splits can be good news for those looking to invest in stocks that have historically been higher priced. As an example, Apple’s stock has split five times since its initial IPO in 1980. If those splits had not happened, Apple shares might have remained out of reach for many investors. At its height, Apple shares were over $700 each. Now they’re about $136 per share.
Pro: May trigger renewed investor interest. When stocks are more affordable, it may attract increased retail interest, which can drive prices upward over the long run.
Con: Could trigger volatility. When there are changes in the price of a particular stock, there’s a risk of triggering volatility as investors move in or out of the stock.
Con: Does not add any new value: At least in the short term, the total value of your assets for the stock in question remains the same. However, if the split does indeed generate increased interest among retail investors, the price per share could increase significantly over the long term.
The takeaway
While there’s often a perception that stock splits add value to your portfolio, that’s not exactly the case. In the short term at least, it’s a wash. The overall value of the stocks that split remain the same. However, if there’s renewed investor interest in the stock as a result of the split, your holdings may become more valuable over the long term as the price ticks upward.
This story was originally featured on Fortune.com
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Now, delving into the article, it provides comprehensive information on the concept of stock splits and their implications for investors. Let's break down the key concepts discussed:
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Stock Split Basics:
- A stock split occurs when a company divides its existing shares into multiple shares, affecting the number of shares held by investors.
- The primary goal is often to make the stock more accessible to a broader range of investors by reducing the unit price of each stock.
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Types of Stock Splits:
- The article highlights that stock splits can occur on various proportions, such as two-for-one, three-for-one, four-for-one, or even higher, like 20-for-1.
- A real-world example is provided with Alphabet (Google's parent company) splitting its stocks 20-for-1 to make shares more affordable to retail investors.
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Reverse Stock Splits:
- Not all stock splits aim to decrease share prices. Reverse stock splits are mentioned, which increase the price per share.
- Companies may opt for reverse splits if their stock price is too low, risking delisting from the stock exchange.
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Impact on Portfolio:
- The overall dollar value of the holdings in an investor's portfolio generally does not change after a stock split.
- Investors end up with more (or fewer) shares, but the value remains the same. The article emphasizes that one share worth $100 is equivalent to two shares at $50.
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Investor Perception and Long-Term Impact:
- Despite the numerical equivalence in value after a stock split, there is a common perception among investors that stock splits add value, especially over the long term.
- The idea is that more affordable stocks may attract renewed investor interest, potentially driving up prices in the future.
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Pros and Cons of Stock Splits:
- Pros include making shares more affordable and potentially triggering renewed investor interest.
- Cons involve the possibility of increased volatility and the acknowledgment that stock splits do not add new value in the short term.
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Conclusion:
- The article concludes by reiterating that, in the short term, stock splits do not add value to a portfolio. However, if renewed investor interest occurs, the price per share could increase significantly over the long term.
In summary, the article provides a comprehensive overview of stock splits, covering their types, implications, and the nuanced perspectives surrounding their impact on investor portfolios.
