What Are Stock Splits? A firm may divide its shares in several ways, and it can do so for a variety of reasons. This article gives an in-depth look at stock splits, including the steps involved, the potential effects on a company’s market value, and any other relevant information.
Stock splits explained
The market value or capitalisation of a firm is unaffected by a stock split, which is just the division or multiplication of its outstanding share count. Each shareholder would have twice as many shares; for instance, if a company issued one additional share for every share investors previously held, the number of shares would double. However, since the corporation will not receive any further cash investment, the total value of all shares in issue will remain the same.
What is a forward stock split?
The most prevalent type of stock split is a forward stock split. They are the process by which a corporation increases the number of shares by issuing new ones to current investors. Assume that you owned 10 shares of business XYZ prior to the division. 30 shares would be yours upon its implementation, assuming that it was a 3-for-1 forward split. However, the aggregate value of your investment would remain constant (at least in theory). Therefore, a forward split results in a lower price per share, but it also increases the number of outstanding shares. The firm’s total market value does not experience any net gain or loss.
What are reverse stock splits?
Some stock splits work in one direction, but a reverse split works the other way. A smaller number of shares is allocated to investors in proportion to the shares they already own.
People who own shares in a company will get one share of stock for every three shares they own after a 1-for-3 reverse split. If you owned 30 shares of a company’s stock before the split, you would now only own 10 shares. It’s important to keep in mind that reverse stock splits usually happen for a detrimental reason, such as when a company’s stock price has dropped significantly.
Stock split ratios
In a forward stock split, the split ratio is the number of new shares issued per share. In a reverse stock split, it is the ratio by which the number of shares is split. In a 3-for-1 stock split, two new shares are issued for each existing share, resulting in three shares after the split.
Furthermore, it’s important to know that the stock split ratio indicates whether the split is forward or backward. In simple terms, a forward split happens when the first number is bigger, like in “3-for-1”. If the first number is less than the second, the split is backward.
Advantages and risks of a stock split
From an investor’s perspective, a stock split might make the company’s shares more affordable for small buyers, as well as for some ETFs and mutual funds. It might also be easier to sell options, and it makes the market for the company’s assets more open in general.
Because of these factors, a stock split could be a way for a company to attract more buyers. Maybe the price of the shares was too high earlier, or the high price made it difficult to use a limit order to buy them.
There are also some possible benefits to a backward split. Some corporations need them to obey the law, such as maintaining a minimum share price. But they can also help a business obtain more investment. For instance, many mutual funds and exchange-traded funds (ETFs) won’t buy stocks trading below $5. A reverse split could help get the shares back into that price range.
When you buy a stock split, there are risks and possible benefits. As I mentioned previously, it is now easier to obtain than it was in the past.
Furthermore, companies usually split their shares when things are going well, which can boost stock prices. But a split could also make the market more volatile, especially if you buy a stock after the company announces the split.
Why do stocks split?
A stock split’s main goal is to lower a company’s stock price so that small investors can buy more shares. Throughout their history, many companies’ boards of directors have split shares many times to keep the share price where they wanted it. It’s also important to keep in mind that after a company split, alternative assets like options would also become cheaper.
It’s important to note that a stock split doesn’t really change the value of your investment. There is a real chance that the factors surrounding the split could make a stock go up or down.
For instance, a company might split its shares to lower its price, which could be a good thing. Many more people can now invest in the company, including people who couldn’t afford even one share before.
This could lead to a surge in demand, driving the stock price up. Don’t worry about this if your company lets you trade partial shares, but for many buyers, big-dollar stocks are out of their price range. One more thing stock splits may signal is that management is confident in a stock’s price, which they can pass on to investors.
What should you expect when stocks split?
There are three key dates investors need to know when it comes to stock splits. They are (in chronological order):
Date of Notice:
The company will first tell the public about the split plans and other important facts buyers need to know. Usually, this information includes the split ratio and when it will happen, as in the times I list in the next two bullet points.
Record date:
The record date is an important date for accountants, but buyers don’t need to know it very much. The record date is the last day you can own a stock to receive the extra shares from a company split. But if you buy or sell stock between the record date and the effective date, you no longer have the right to the new shares.
Effective Date:
The day that buyers’ trading accounts get the new shares, and the shares trade based on how they are traded after the split.
It sounds hard, but it’s really not that hard. If your account has more shares after a stock split, you will see the change on the next business day. In line with these expectations, the share price should change.
Stock split examples
- Alphabet (GOOGL +0.99%) (GOOG +0.78%) announced a 20-for-1 stock split, its first in eight years, with an effective date of July 15, 2022.
- NVIDIA (NVA -1.07%) announced a 4-for-1 stock split in mid-2021, effective July 20, 2021.
- Tesla (TSLA +0.01%) announced a 5-for-1 stock split along with its second-quarter 2020 earnings report, with an effective date of Aug. 31, 2020.
- The Trade Desk (TTD +1.53%) announced a 10-for-1 stock split in 2021 after years of stellar stock performance, with an effective date of June 17, 2021.