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Understanding Stock Splits: An Investor's Guide

Updated: Feb 13

A stock split is a decision by a company's board of directors to increase the number of outstanding shares by issuing more shares to current shareholders. For investors, the concept of a stock split might sound perplexing at first, but it’s a fairly common practice. In this article, we'll delve into the reasons behind a stock split, its implications, and offer some notable examples.

What is a Stock Split?

In a stock split, the total value of the shares remains the same compared to its pre-split amounts. This means that even though the number of shares increases, the total dollar value remains unchanged because the price of each share reduces proportionally. For instance, in a 2-for-1 split, every shareholder receives an additional share for every share they hold. However, the price of each share is halved. So, if you had 10 shares of a company priced at $100 each, after the split, you'd have 20 shares priced at $50 each.

Why Do Companies Opt for Stock Splits?

  • Market Perception: Companies might believe their stock price is too high or out of range when compared to their competitors. By lowering the price, they may feel it appears more affordable to retail investors.

  • Liquidity: Increasing the number of shares can improve trading liquidity. With more shares available, buying and selling become easier and can lead to smaller price fluctuations.

  • Psychological Boost: A lower share price can sometimes be perceived as a buy opportunity, potentially encouraging more investors to take interest.

Implications of a Stock Split for Investors

  • No Direct Value Change: It's vital to understand that a stock split, in itself, doesn’t change the intrinsic value of an investor's holding. If you owned 1% of a company before a split, you'd still own 1% after the split.

  • Potential Indirect Effects: While the split doesn't change company value, the increased liquidity and psychological appeal might buoy the stock price over time due to increased demand.

  • Dividend Implications: If a company pays dividends, post-split, the dividend per share will likely reduce in line with the reduction in share price. However, because shareholders will now own more shares, the total dividend payment remains unchanged.

  • Tax Implications: Typically, stock splits don't create a taxable event for investors. The original purchase cost gets spread over the increased number of shares.

Notable Examples of Stock Splits

  • Apple Inc.: Apple has split its stock five times since going public. One of the most recent was in August 2020, when Apple conducted a 4-for-1 split. Before the split, its stock price was around $500. Post-split, the adjusted price was about $125.

  • Tesla, Inc.: In the same month as Apple's mentioned split, Tesla announced a 5-for-1 stock split. This reduced the share price from roughly $2,200 pre-split to about $440 post-split.

  • The Coca-Cola Company: One of the longest-standing companies on the stock market, Coca-Cola has split its stock 11 times since its listing in 1919.

It's worth noting that companies can also conduct reverse stock splits, where they reduce the number of shares to increase the share price. This is often done to meet listing requirements of stock exchanges or to make the stock more appealing to institutional investors. However, a reverse stock split can sometimes be perceived negatively as it might indicate issues with the company's underlying business.

Stock splits can often generate excitement around a stock and may influence trading in the short term. However, as an informed investor, it's vital to understand the mechanics and implications of such corporate actions. A stock split doesn't change a company's fundamentals, so investment decisions should remain rooted in thorough analysis of the business and its prospects.

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