Complete Guide to Stock Splits
In this guide, we explain everything there is to know about stock splits.
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New to stock splits? Amid the COVID-19 crisis, they caught the attention of many investors after the headline-worthy splits involving Apple and Tesla. 📰
On August 31st 2020, two of the world’s leading tech giants, Apple (AAPL) and Tesla (TSLA) split their stock, gaining global traction.
Stock prices in both companies soared following the opening bell, capturing the attention of investors in not just the stocks, but in the concept of stock splitting itself.
This was the fifth time Apple executed a stock split since it went public in 1980. The stock was split on a 4-to-1 basis, dividing up Apple shares, which were trading close to $420 on July 31st.
This was the first time Tesla performed a stock split. It announced a 5 to 1 split on August 11th, following Apple’s announcement. At the time, shares in Tesla were heavily priced at around $1,400.
If stock splits are new to you, you’re not alone. Splits used to be quite common on the S&P 500 but have become less frequent in recent years. This has presented a notable disadvantage to investors. Despite this, stock splits can have several advantages for current shareholders—especially short-sellers. 💡
In this guide, we’ll take you through what a stock split is, why a company generally performs a stock split, and how you can take advantage of one.
- What is a Stock Split?
- What is a Reverse Stock Split?
- How Stock Splits Could Help a Company
- Example of a Stock Split: Apple & Tesla
- Is ‘Fractional Trading’ Still a Thing?
- Why Would a Company Split Stock?
- Do Stock Splits Affect Short Sellers?
- Can You Take Advantage of a Stock Split?
- The Bottom Line
- Choose Your Stock Broker
What is a Stock Split? ➗
All publicly-traded companies have a set number of outstanding shares. A company’s board of directors might decide to implement a stock split to increase the number of outstanding shares while lowering the stock price. In many cases you will need to be a shareholder before a certain date, decided by the company, to benefit from the stock split.
How Does a Stock Split Work? 🍕
Stock splits can be quite complicated to understand, and are explained by arithmetic, like “2-for-1” or “4-for-1.” We thought it would be a cool idea to explain using something most of us love (and myself, a bit too much): pizza.
Let’s think about a large pizza and imagine that it represents the company’s value. When the stock first started trading, the company sliced the pizza into an infinite number of slices—shares—and sold them for a price. To simplify things further, let’s say the pizza was cut into eight slices and investors bought one share.
Often, a company will announce a 2-for-1 split which means that each share is split into two, making twice the amount of shares, and each share cheaper to buy. If you had one share, representing one-eighth of a pizza to begin, you now have two shares, each representing one-eight.
It’s the same amount of pizza, but a different quantity. This principle is applied no matter the split ratio.
When a company decides to implement a stock split it chooses a specific day to do so. Then, at the close of business, the number of shares will be converted in line with the chosen stock split. The company will set another date for trading to start on a split-adjusted basis.
What are the Pros & Cons of a Stock Split? 💸
Below we highlight the pros and cons of splitting shares.
Pros
- Keeps them affordable
- Prevents companies from looking ‘overvalued’
- Helps investors with portfolio composition
- Increases liquidity of a company
- Potentially a positive sign for the future
Cons
- “Affordable” changes with the times
- Weakens the shareholder base
- Nothing changes fundamentally
- Lower-priced stocks have wider bid-ask spreads
In relation to our point about the concept of what is considered “affordable” changing over time (especially during a pandemic), it must be noted that because there have been increasingly less stock splits over the years, the price of stock has been on a steady incline, making them more expensive than ever to buy.
What is a Reverse Stock Split? 🎯
Companies can also implement a reverse stock split. Companies with low shares prices generally use this procedure to increase the prices of shares.
A company might consider this if they expect their shares will be delisted or in order to gain more respect on the market. Companies can be delisted from stock exchanges if their share prices fall below a particular per share price.
For example, when a reverse stock split of 1-for-5 is announced, 10 million shares that are outstanding at $0.50 cents per share would become two million outstanding shares at $2.50 per share. In either case, the company is valued at $5 million.
In May 2011, Citigroup announced a reverse split of 1-for-10 with the aim of reducing share volatility and discouraging traders from speculating. The reverse split caused shares to rise from $4.52 to $45.12 after the split. While the split meant that there were now less shares in the market, the company’s value on the market remained the same (about $131 billion).
⚡️ Want more details? See our comprehensive guide to reverse stock splits.
How Stock Splits Could Help a Company 💡
When a company’s share price increases to levels that are too high, or are beyond the price levels of similar companies in their sector, they may decide to do a stock split. The reason for this is that a stock split makes shares more accessible for smaller investors to buy which increases demand.
It also makes the company more liquid in the stock. Understanding the difference between common stock and preferred stock should be first on your list as each brings with it different benefits and privileges.
When a stock splits, it can also drive up the share price, even though it might fall immediately after, as we saw with Tesla and Apple (discussed further in a moment).
The price might also potentially increase because the stock split signals to the market that the share price of the company is rising; people usually take this to mean that it will continue rising. And as psychology would suggest, this train of thought effectively increases the demand and prices further.
A Real-Life Example of a Stock Split: Apple & Tesla 📈
Recently, two of the world’s most popular stocks announced a split: Apple and Tesla. This reduced the price per share, making them more accessible for investors. And yes, investors jumped at the opportunity, causing shares to jump.
Shares in Tesla, which were split 5-for-1, surged 12.6%, adding $50 billion to its market cap, while Apple soared after splitting its shares 4-for-1, gaining 3.4%, tacking on more than $70 billion in market value. Apple is now worth $2 trillion, doubling its value in just two years.
But some reckon this boost may have run its course. Shortly after Apple fell by over 4% from their record, while Tesla slipped from its record high, dropping by 14.7%. On the other hand, some experts predict that the stock split could have positive long-term effects, pushing them 33% higher over the next year.
In recent years, stock splits have become rare on Wall Street, with only three S&P 500 members announcing a stock split in 2020. This pales in comparison to an average of ten a year over the past decade.
Is ‘Fractional Trading’ Still a Thing? ✅
Fractional trading has largely minimized the issue of accessibility for traders. Leading brokers like Interactive Brokers, Robinhood and Fidelity offer investors the opportunity to buy shares of less than 1.
For example, an investor might place an order for half a stock with $500 and pay only $250. In this case, the broker buys a whole share for $500, sells 0.5 to an investor, and keeps the other half.
💡 Looking to enter the world of fractional trading? See our in-depth Robinhood review.
An often-overlooked form of investing is dividend investing. If you’re looking for a retirement investing strategy, get to know more about the often overlooked dividend investing, and how it can offer you greater returns than the previously sought after 4% drawdown method.
Another suitable option to consider might be, swing trading. It’s particularly good in times of market uncertainty, when prices swing from one end of the coin to the other in the blink of an eye.
Why Would a Company Split Stock? ⚖️
As we mentioned above, a company splitting its stock might be a sign that the company expects its price to continue to rise.
Although stock splits do not represent the company’s fundamentals in any way, its decision to increase shares implies that the company’s shares are in high demand.
But just because a company is in demand doesn’t necessarily mean it will do a stock split. For example, shares for Berkshire Hathaway’s Class A are renowned for being expensive. As of July 31st, one singular share in the company would cost you a cool $291,906.25, more money than you can shake a stick at.
Do Stock Splits Affect Short Sellers? 🔎
Stock splits affect short sellers but not in a material manner. Some changes happen as a response to the split that affects the short position. However, it doesn’t impact the value of the short position.
The biggest effect it will have on your portfolio is the amount of shares being shorted and how much each share will cost.
When investors short a stock, they borrow shares with the agreement they will be returned at at a date in the future.
An Example of How a Split Stock Works? 🧠
For example, were an investor to short 100 shares at corporation X at $20, they will be expected to return all of the company’s shares of X to the lender at a date in the future. Should the stock undergo a stock split before the shares are returned, the amount of stocks that need to be returned will be equal to the increase in stocks generated by the split.
When shares are split by a company, the price of the shares splits too. For example, let’s say the shares of company X were trading at $100 before the split took place. Once the split happens, the shares are half the size, and therefore, worth half the amount.
The stock that was previously priced at $100, will not be valued at $50. If an investor owns ten shares for a total of $1,000, post split, they will own 200 shares at $50 each, totalling $1,000.
💡 Considering short selling? Take a look at our top brokers for short-selling to give you a better idea of where to start.
When it comes to short investors, before the split, they will be expected to return 10 shares. After the split, they will be expected to return 20 shares. If the short-seller closes their position after the split, they can buy 20 shares for $50 and return them to the lender.
This will earn the short investor a profit of $500 (money received after sale ($70 x 10) minus the cost of shorting ($50 x 20). This is $1,400 – $1,000= $400. The short was 10 shares at $100, which is equal to 20 shares at $50. Therefore, the short made $10 per share on the 10 shares borrowed, or $20 per share if they shorted before the split.
Can You Take Advantage of a Stock Split? 📈
To take advantage of a stock split you will need to hold stock in the applicable company by a specified date.
If you’re not an investor in the company when the stock split is announced, and you think it might be a good option for you now that shares are more accessible, make sure to do your research first to confirm that it’s a strong option for your portfolio. In addition, knowing the difference between growth stocks and value stocks, (the two major kinds) will help you make a more informed decision.
COVID-19 has caused some serious fluctuations in the stock market and the economy, raising some concerns and questions. Make sure your decision is informed, taking into consideration the wider stock market, which is linked only loosely to fundamentals.
The Bottom Line 🏁
In the majority of cases, a stock split is used by companies that have an increased demand in its stock. Although the amount of shares outstanding is increased, the price per share reduces comparatively, the value of the company remains the same.
For this reason, stock splits make shares more accessible to smaller investors and increase their liquidity.
Now you’re a pro when it comes to stock splits! 🎉 If you’re interested in trading stocks, but you’re not sure where to start, choosing a reliable, trustworthy broker is crucial to your success. Here are our recommendations:
Stock Split FAQs
-
What is the Definition of a Stock Split?
A stock split, also known as a stock divide, creates more shares in a company. The stock split makes individual shares cheaper, without affecting the total market capitalization of the company.
-
What is a 2 for 1 stock split?
When a company does a 2-for-1 stock split, stock held by current shareholders is divided into two. So, if a company has 1 million outstanding shares before the split, it will have 2 million outstanding shares after the split. This will make each stock half the price.
-
What Exactly Happens When a Stock Splits?
When a company decides to do a stock split of its shares that are outstanding, it issues more shares to current shareholders. Although this increases the number of outstanding shares and reduces the price share, the market capitalization of the company remains the same.
-
What’s the Main Reason a Company Splits its Stock?
A stock split is an action taken by a company to increase the amount of shares that are outstanding by issuing more shares. Mainly, companies do this to make shares more affordable for smaller investors and meet demand.
-
What are Some Recent Stock Splits?
On August 31st, two tech giants, Apple and Tesla implemented stock splits. Apple used a 4-for-1 stock split while Tesla performed its first ever stock split at 5-for-1.
-
Example of a Stock Split
Let’s look at a 2-for-1 stock split as an example. In this case, each shareholder gets an additional share, worth half the amount. If the company has two million shares outstanding before the split, then it will have four million shares outstanding after the split.
-
What is a 1-to-10 Reverse Stock Split?
Companies can implement a reverse stock split, which is the opposite of a stock split. A reverse stock split of 1-to-10 will result in every ten shares accumulating into one.
-
How Many Times Has Apple Split Stock?
Apple has performed a stock split a total of just five times since it went public. The company’s last stock split was in June, 2014.
-
Is a Stock Split a Good Thing?
In some cases, a stock split is a positive indicator that the company expects its shares to keep rising. While this can be so, a stock split is in no way a reflection of the fundamentals of the company. When determining the effectiveness of stock, you could consider factor investing, which has soared in popularity over the past five years as a “strategic” beta strategy.
-
When Do Stocks Split?
A company typically decides to split stock when it is in high demand, making shares more expensive for investors to buy. For example, on July 31st, Apple stock had climbed to $420.
-
Can You Lose Money When Stocks Split?
When a stock splits you will have more stock that equals the same total value. For example, if you have one stock worth $20, and a split of 2-for-1 happens, then you will simply have two stocks worth $10 each, totalling $20.
-
Do Stock Prices Usually Go Up After a Split?
When a stock splits, in some cases, it can cause a rise in share prices – even though they might be worth less directly after the split. This happens when the drop in price results in more investor interest, driving up demand and prices.
-
Should You Buy Stock Before or After a Stock Split?
Throughout COVID-19 more companies are issuing shares, raising record amounts.
Though, there is no way to predict that a company will do a stock split. If you are not a shareholder when a company performs a split, make sure to research whether it is a good option for your portfolio.
-
Which Stock Has Split the Most?
While stock splits used to be very common in the stock market, they have become less so in recent years. To stay on top of which companies are doing stock splits, you can check out the Nasdaq Stock Splits Calendar.
-
Can You Tell if a Stock will Split?
There are no particular requirements or guidelines that will indicate that a company will split its stock. In most cases, companies split stock when there is a rise in demand, and thus a rise in the price of its stock.
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All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.
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