What is a stock split?
By issuing more shares to shareholders and potential investors, companies essentially add more slices to the pie without changing the overall value of each share.
The most common stock splits are 2-for-1 or 3-for-1, where shares might increase from 1 million to 2 million and 3 million respectively. That means that if you held one share before a stock split, you will now hold 2 or 3. Companies which have issued a stock split, such as Amazon and Apple, have done so in order to lure investors in by making shares more affordable, and therefore attractive.
KEY TAKEAWAYS
- A stock split is when a company multiplies the number of shares in order to boost liquidity (i.e. make trading more seamless)
- The most common stock splits are 2-for-1 or 3-for-1 and are put in place to draw investors into lower prices
- A stock split does not increase or decrease the value of shares
- Companies split stocks when the price per share becomes too high, indicating that the company is a strong and healthy company worth investing in
What happens when a stock splits?
When a company issues a stock split, they multiply the number of outstanding shares. For example, if a company holds 1 million shares and issues a 2-for-1 stock split, the company will now hold 2 million shares. That means that if the price per share is $100, the value will simply halve and drop to $50 per share. But it’s important to note that while the number of shares increases, the overall value doesn’t change. But by lowering the price per share, the company increases liquidity by improving its tradability.
Therefore, it’s important to note that a stock split does not increase or decrease the value of shares. Instead, it just makes it more affordable for potential investors when the share price of a company increases. For example, if a company’s shares increase in value from $5 to $10, it is more alluring for an investor to see that they can buy a share for $5 rather than $10. Shareholders don't lose any money because of a stock split!
Are stock splits good?
So is it a good thing? A stock split is actually a positive move. That’s because when companies issue a stock split, it’s because the price of a stock has become too high. So a stock split actually indicates a strong and healthy company worth investing in.
And does that mean you can get rich through a stock split? Well, the short answer is no – a stock split does not necessarily make investors rich. That being said, it is good to invest in a stock split because stock splits usually lead to a swarm of investors pumping money into the company. So with that, you can expect your share price to increase in value if you buy when the stock split is first initiated. It might even prove better to buy a stock before it splits, so you can get in at a good price before it shoots up in value.
Why do companies split stocks?
- Improve liquidity: Companies issue stock splits to improve the liquidity of their shares and increase buy and sell transactions within the stock market. If a stock price is high, then it makes it more difficult for people to buy and sell. So, by decreasing the value per share, transactions are made more fluid.
- Affordability: It’s simply a way for companies to alter the perception of affordability to potential individual investors, especially those who aren’t coming into the market with lots of money to invest. Therefore, it’s not aimed at big financial institutions who pump money into their stocks, but at individual investors like us whom they need to attract.
- Increase investment: Stocks typically go up post split as more investors flurry in to get their slice of the pie at (what seems like) a discounted price.
Stock split examples
Apple and Amazon are two companies which have recently initiated stock splits to increase the liquidity of their stocks.
Apple's stock has split five times since the company went public. The stock split on a 4-for-1 basis in August, 2020, a 7-for-1 basis in June 2014, and split on a 2-for-1 basis in February 2005, June 2000 and June 1987.
In March 2022, Amazon.com Inc. (AMZN) announced its first stock split since 1999 where it split stock by 20-1. The decision came into force on 6 June 2022. Shareholders therefore got an additional 19 shares for every 1 share they held. The price of shares after the split went to about $122, or $2,447 divided by 20.
Advantages of a stock split
For individual investors, the benefits of a stock split are as follows:
- Affordability: By decreasing the value per share, investing becomes more affordable to investors entering the market.
- Increased liquidity: The buying and selling of shares becomes notably easier with more slices of the pie floating around the marketplace.
- Diversification: With more shares at a lower price, it’s easier to counterbalance those swinging portfolios through diversification.
- Higher returns: With stock splits, comes higher market activity. That means that with more people buying into the company’s shares, stock prices are likely to shoot up meaning you can potentially sell off stocks for higher than you bought them.
Disadvantages of a stock split
Although there are many advantages to companies issuing a stock split, there are also a few disadvantages to keep in mind:
- Higher volatility: Whilst prices are likely to skyrocket after a stock split, it does mean that a company’s shares are more prone to volatility.
- Costly for businesses: It’s not free for a company to issue a stock split. The process of splitting a stock is a lengthy and costly one, since it requires bankers and record keepers to update electronic shareholder records.