What is a stock split?
Editorial staff, J.P. Morgan Wealth Management
- A stock split is when a company breaks up its existing shares to create more shares at a lower value per share.
- Stock splits reduce the trading price of a stock, making it both more liquid and more affordable for investors.
- A reverse stock split is when a company combines its shares into fewer, more valuable shares. As a result, you get fewer shares at a higher price each, but your net investment value stays the same.
An impending stock split tends to be significant news for shareholders and prospective investors alike. But news of a stock split can also raise a few questions. Here we’ll cover what a stock split is, why companies split a stock and what some of the impacts might be.
What is a stock split?
A stock split occurs when a company breaks up its existing shares into multiple, lower-value shares. This action reduces the trading price of a stock, making the company’s shares more affordable and more liquid for investors. When a stock split occurs, the number of shares outstanding increases, but the total market capitalization – or value of the company as a whole – does not change. This means you get more shares at a lower price per share while your net investment value stays the same.
To visualize what happens when a stock splits, think of it like this: When you cut a pizza into smaller pieces, the size of each piece is smaller but the total amount of pizza and the value of the entire pie do not change. There are, however, more slices to share. The same is true about the value of a company when a stock split takes place.
Why do stock splits happen?
Companies often decide to split a stock when they believe that their stock price is too high compared to stock prices of similar companies. Again, a stock split reduces the price of a company’s individual shares, making it easier for smaller investors to buy the stock. This makes the stock more liquid, giving buyers and sellers more flexibility. It also means that, even when trading volume is high, it may not have a significant impact on a stock’s price. More liquidity can also cut down on trading slippage for companies during share buyback initiatives.
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Stock split examples
Say a company decides to enact a 2-for-1 stock split. If it had 5 million outstanding shares prior to the split, it would now have 10 million outstanding shares after the split. The company’s stock price would be halved after the 2-for-1 split. A company can split a stock by any ratio, assuming the action is approved by voting shareholders and the board of directors. Stock split ratios are often denoted with colons, like 2:1 stock split or 3:1 stock split.
One famous stock split took place in 2014, when Apple executed a 7:1 stock split so more small investors would be able to purchase its shares. This meant that an investor who owned 100 shares of Apple stock before the split owned 700 shares afterward. Before the split took place, the opening price for the stock was about $650. Following the split, the new price was one-seventh of the original – about $93. Other large, successful companies engage in regular stock splits as their stock price increases over time.
Is stock splitting good or bad?
A stock split is neither good nor bad. Stock splits present certain opportunities and challenges. Whether it’s good or bad depends on the company, market and your unique financial situation. Let’s look at some of the common pros and cons of a stock split:
Stock split pros
Some of the possible pros of a stock split include:
- Makes shares more affordable: A stock split reduces the price per share, offering more investors a chance to purchase shares.
- Increases liquidity: The increased affordability can attract a wider pool of investors, potentially making trading easier.
- Signals confidence: Companies often split stocks when they are optimistic about future growth, so news of an upcoming stock split may signal investor confidence.
Stock split cons
The potential disadvantages of a stock split might be:
- Increased costs for the company: Stock splits come with administrative and operational expenses that the company must pay for.
- Potential volatility: A stock split may lead to temporary fluctuations in the stock price, affecting market stability in the short term.
- Unchanged value: Splitting stocks doesn't directly increase the market cap or the total value of shares held.
Stock split: Upsides and downsides
Stock split pros | Stock split cons |
|---|---|
Affordability and volatility | |
Shares become more affordable | May introduce short-term price volatility |
Liquidity and costs | |
Stock liquidity increases | Involves additional costs to the company |
Perception and value | |
Shows confidence in the company | Does not change overall market capitalization or value |
Investor base | |
May expand the investor base | |
What is a reverse stock split?
A reverse stock split is just what it sounds like: the reverse of a common split. Instead of splitting shares into a greater number of lower-price shares, a reverse stock split means that a company consolidates its shares into fewer, more valuable shares. For example, in a 1:2 reverse stock split, 10 million shares costing $1 each would become 5 million shares costing $2 each.
Companies usually engage in a reverse stock split when they believe that their share price is too low. Companies are sometimes delisted from exchanges if their stock price falls below a certain level, so a reverse stock split is one potential way to prevent this. Just like in a normal stock split, the company’s total market capitalization remains the same after a reverse stock split.
The bottom line
During a stock split, a company increases its total number of shares by dividing existing shares into more, lower-value shares. This makes shares more accessible to investors while keeping the overall market value the same. Stock splits can enhance share liquidity and potentially signal increased confidence but may introduce some short-term price volatility. To understand how an upcoming stock split might align with your financial goals, consider speaking with a qualified financial advisor.
Frequently asked questions about stock splits
Companies split stocks to increase the number of shares available and reduce their price per share, making them more accessible to investors. This can increase liquidity, broaden the investor base and potentially attract new interest without diluting the overall market value.
No, a stock split does not inherently increase the value of shares or a company’s valuation. If a company decides to split shares in half, for example, each individual share would be worth half its initial value. Therefore, they do not change valuation on their own. However, more subjective factors regarding stock splits can impact valuation. For example, the decreased price for one share may attract would-be investors who previously were priced out of the stock. Additionally, hype, market sentiment and perception around a stock split may have the potential to attract investment.
A reverse stock split consolidates shares, reducing the total number of outstanding shares on the market while raising their individual value. Whether it’s good depends on the company’s specific circumstances and your investment goals. It may help raise the share price and meet exchange listing requirements but doesn’t directly change the overall market capitalization.
By reducing the number of available stock shares, a company can increase the trading price of each share. There are many reasons why a company would want to increase share price. For example, a reversal might help the share price meet minimum bid requirements at the exchange where the shares are traded.
A 2:1 stock split means that for every share you currently own, you'll receive two shares after the split at half their original value.
To calculate a stock split, multiply the number of shares you own by the split ratio to determine the new quantity of shares. Divide the original share price by the same ratio to find the new value per share. For example, in a 3:1 split, owning 100 shares valued at $30 each would result in 300 shares valued at $10 each.
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Editorial staff, J.P. Morgan Wealth Management
