A stock split is a corporate action in which a company divides its existing shares into multiple shares. It usually occurs when the stock price gets too high, and the company wants to make it more affordable for smaller investors. When a company splits its stock, the value of each share decreases proportionally.
While stock splits are generally seen as positive news for investors, there are some things you need to be aware of before deciding whether or not to buy into a split. In this article, we will take a look at what exactly happens when a stock splits and what it means for both companies and investors.
What does stock split means?
For example, if a company has 100 shares of stock worth $10 each and decides to do a 2-for-1 split, then each shareholder would end up with 200 shares worth $5 each. The total value of the company's outstanding shares would remain the same at $1,000, but each shareholder would now own twice as many shares.
A company can choose to split the stock by any ratio. It can be 2-for-1, 3-for-1, 5-for-1, 10-for-1, 100-for-1 and so on. For example, on June 2022, Amazon.com, Inc. (AMZN) split its stock on a 20-for-1 ratio, from more than $2,000 to about $125. That made it much easier for investors to get in on the stock.
Why do companies split their stock?
There are a few reasons why companies might decide to split their stock.
- One reason is that it can make the stock more affordable for small investors. When a company's stock price gets too high, it can become difficult for smaller investors to buy shares. By splitting the stock, the company can make it more affordable and accessible to a wider range of investors.
- Another reason is that it can increase the liquidity of the stock. When there are more outstanding shares, it can be easier to buy and sell the stock, which can attract more investors and help to drive up the price.
- Finally, splits can signal to the market that the company's stock is doing well and is expected to continue to rise in value.
However, there are companies that, due to their philosophy, consciously avoid a stock split — for instance, Warren Buffet's company, Berkshire Hathaway (BRK.A). As of August 2022, the price for this share is about $442,210.00.
Many companies also do not take this step because the process is costly and complicated from a legal point of view.
What can happen if a stock you own splits?
Imagine you own shares of a company that announces a stock split. The number of shares you own will increase proportionally. For example, if you own 100 shares of a company that does a 2-for-1 split, you will end up with 200 shares after the split.
The value of your investment will not change due to the split. So, if you owned 100 shares worth $10 each before the split, you would still have an investment worth $1,000 after the split.
However, the price of each share will decrease. So, if the shares were worth $10 each before the split, they would be worth $5 each after the split.
This can be good or bad, depending on the market situation. On the one hand, as the stock becomes more affordable and attractive, the stock price can go up. However, if the stock market goes deep down, the stock price will also likely fall.
Reverse Stock Split.
Sometimes, the company might do a reverse stock split. This is when the number of shares outstanding is reduced, and the price of each share increases.
For example, if a company does a 1-for-2 reverse split, each shareholder would end up with half as many shares as they had before. But those shares would be worth twice as much.
Reverse stock splits are usually done by companies whose stock price has fallen so low that it's in danger of being delisted from exchanges. A reverse split can help boost the stock price and make it more attractive to investors.
Should you invest after a stock split?
It depends on many factors, including the market conditions at the time, the company's financial situation, and your investment goals. You'll need to do your research to determine whether or not investing in a particular stock is right for you.
If you're considering investing in a company that has just announced a stock split, you might want to wait until after the split takes place. This will give you time to see how the market reacts to the news and ensure you're comfortable with the new price per share.
