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When a company is concerned that its share price is too high or too low, it can opt for a stock split or a reverse stock split. A stock split can help a company lower its share price to appeal to new investors, while a reverse stock split can boost its share price and help preserve its listing on a major stock exchange.
What Is a Stock Split?
A stock split is when a company’s board of directors issues more shares of stock to its current shareholders without diluting the value of their stakes. A stock split increases the number of shares outstanding and lowers the individual value of each share. While the number of shares outstanding change, the overall market capitalization of the company and the value of each shareholder’s stake remains the same.
Say you have one share of a company’s stock. If the company opts for a 2-for-1 stock split, the company would grant you an additional share, but each share would be valued at half the amount of the original. After the split, your two shares would be worth the same as the one share you started with.
What Is a Reverse Stock Split?
A reverse stock split reduces a company’s number of shares outstanding. If you owned 10 shares of stock in a company, for example, and the board announced a 1-for-2 reverse stock split, you’d end up with five shares of stock. The total value of your shares would remain consistent. If the 10 shares were valued at $4 per share before the reverse split, the five shares would be valued at $8 per share after the reverse split. In either case, the total value of your investment remains $40.
Why Do Companies Split their Stock?
In many cases, a stock split is a strategy used by companies to meet a specific goal, says Amanda Holden, a former investment counselor and the founder of Invested Development, a course aimed at helping women learn about investing.
Companies often like the idea of creating more liquidity by making a price more attractive and attainable for a larger number of people. “You might not be able to buy Apple at $500, but you could buy it at $125,” she says.
On the other hand, a reverse stock split is often aimed at helping a company meet the minimum requirements to remain listed on an exchange.
“You can get kicked off an exchange if your price drops too far,” Holden says. “A reverse stock split consolidates your shares in a way that results in a higher per-share price that can keep you trading on a public and accessible exchange.”
This helps ensure more people can access the shares and keeps existing shares liquid. While a reverse stock split is often thought of as a red flag for investors, in the long run, it can help a company survive and recover from a rough patch.
What Is a 2 for 1 Stock Split?
A 2-for-1 stock split grants you two shares for every one share of a company you own. If you had 100 shares of a company that has decided to split its stock, you’d end up with 200 shares after the split.
A 2 for 1 stock split doubles the number of shares you own instantly. Two-for-one and 3-for-1 stock splits are relatively common, says Holden. While Apple (AAPL) and Tesla (TSLA) have gotten a lot of publicity for their 2020 stock splits, their 5-for-1 or 4-for-1 stock splits were uncommon choices.
How Does a Stock Split Affect You?
Because a stock split doesn’t change the underlying value of your investment, you may not notice any more substantial changes than the number of shares in your investment account.
“There’s no particular advantage for those who already have shares,” Holden says. “Nothing about ownership is going to change. You might have twice as many shares, but they are at half the price, so it balances out.”
For those who aren’t already shareholders, though, a stock split can provide motivation to buy. For example, if you couldn’t afford a share of Tesla before its recent stock split, you might be able to get one now.
The ability for more people to buy a stock can bump up its price, which in turn may actually increase a company’s value, at least temporarily, Holden says.
“With more people able to buy, you see more demand, and the price can go up. If you have more shares, this can be beneficial to you if you hold on,” Holden says. “However, that stock and total value bump is generally temporary. To see long-term gains, you usually need to keep holding that stock to get the benefit over time.”
Are Stock Splits Important with Widespread Fractional Share Investing?
As fractional investing becomes more popular and widespread, some experts speculate that stock splits will become less important as fractional shares allow you to buy into a company at virtually any price point.
Currently, investing apps like Robinhood, Stash, M1 Finance and SoFi Invest, as well as legacy brokerages like Charles Schwab and Fidelity, allow clients to buy fractional shares of certain stocks and exchange-traded funds (ETFs).
“It’s hard to say how fractional investing will impact investing and stock splits since there isn’t a lot of data right now,” Holden says. “But I think it will take significant time before fractional investing eliminates the need for stock splits.”
And that’s not even considering the psychological aspect of stock splits. “Humans love a round number,” says Holden. “There’s something about knowing you have the money to buy a full share that motivates many investors.”
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The Bottom Line
In the end, a stock split—or even a reverse stock split—doesn’t have a huge practical impact on a company’s current investors. A stock split’s biggest impact is on investors who might be watching a particular stock and hoping to purchase a full share for a lower price. For those investors, a stock split can provide a powerful motivator to get off the sidelines.
As an investment enthusiast with a deep understanding of financial markets and corporate strategies, I can confidently dissect the concepts presented in the article and provide a comprehensive overview.
Stock Split: A stock split is a strategic move by a company's board of directors to issue additional shares of stock to existing shareholders without affecting the overall value of their holdings. This process increases the total number of shares outstanding, thereby reducing the individual value of each share. The goal is often to make the stock more attractive and affordable for a broader range of investors. In the case of a 2-for-1 stock split, for example, shareholders receive an additional share for each share they own, but the value of each share is halved.
Reverse Stock Split: Conversely, a reverse stock split is employed to decrease the number of shares outstanding. This can be done to boost the share price, making it more likely for the company to meet the minimum requirements for listing on a major stock exchange. In a reverse stock split, shareholders receive fewer shares, but the value per share increases. The total value of the investment remains constant.
Reasons for Stock Splits: Companies may opt for a stock split to enhance liquidity, making their stock more accessible to a larger number of investors. This can be particularly appealing for retail investors who may find a lower-priced stock more affordable. On the other hand, a reverse stock split is often used to prevent the company's share price from falling too low and risking delisting from a stock exchange.
Impact on Investors: For existing shareholders, a stock split or reverse stock split typically has no significant impact on the overall value of their investment. While the number of shares changes, the proportional value remains the same. However, these actions can influence investor psychology and, in the short term, may attract new investors or meet listing requirements.
Fractional Share Investing: With the rise of fractional share investing facilitated by platforms like Robinhood, Stash, and others, the importance of traditional stock splits is debated. Fractional investing allows investors to buy portions of shares at virtually any price point, potentially diminishing the need for stock splits. However, the psychological aspect of whole share ownership remains a motivating factor for many investors.
Long-Term Effects and Considerations: The article suggests that while stock splits may lead to short-term gains due to increased demand, these gains are often temporary. Long-term success depends on the company's performance and the ability to sustain value over time. Additionally, the article introduces the idea that as fractional investing becomes more prevalent, the impact of stock splits on market dynamics may diminish, but this trend is still in its early stages.
In conclusion, the practical impact of a stock split or reverse stock split on existing investors is relatively limited. The primary significance lies in attracting new investors and meeting listing requirements, with the evolving landscape of fractional share investing adding another layer of complexity to these dynamics.
