Stock Split

Where an organization issues extra shares to shareholders, raising the total by a specific ratio based on their previously held shares.

Author: Christopher Haynes
Christopher Haynes
Christopher Haynes
Asset Management | Investment Banking

Chris currently works as an investment associate with Ascension Ventures, a strategic healthcare venture fund that invests on behalf of thirteen of the nation's leading health systems with $88 billion in combined operating revenue. Previously, Chris served as an investment analyst with New Holland Capital, a hedge fund-of-funds asset management firm with $20 billion under management, and as an investment banking analyst in SunTrust Robinson Humphrey's Financial Sponsor Group.

Chris graduated Magna Cum Laude from the University of Florida with a Bachelor of Arts in Economics and earned a Master of Finance (MSF) from the Olin School of Business at Washington University in St. Louis.

Reviewed By: Christy Grimste
Christy Grimste
Christy Grimste
Real Estate | Investment Property Sales

Christy currently works as a senior associate for EdR Trust, a publicly traded multi-family REIT. Prior to joining EdR Trust, Christy works for CBRE in investment property sales. Before completing her MBA and breaking into finance, Christy founded and education startup in which she actively pursued for seven years and works as an internal auditor for the U.S. Department of State and CIA.

Christy has a Bachelor of Arts from the University of Maryland and a Master of Business Administrations from the University of London.

Last Updated:November 5, 2023

What Is a Stock Split?

A Stock Split occurs when a corporation decides to raise the number of outstanding shares by some certain amount. It is done to increase the liquidity of a particular company’s stock.

A stock split is an organization's action in which they issue extra shares to shareholders, raising the total by a specific ratio based on their previously held shares.

A corporation sets a split ratio when it decides to split the stock. The corporation can choose from a wide range of combination ratios. The most common splits are 2 for 1, 3 for 1, and 3 for 2. 

As the split fundamentally does not impact the company’s worth, the total dollar value of all the outstanding shares remains the same, and even the number of shares outstanding grows by a specific number.

When a corporation is concerned about the high price of a stock, it performs a split to lower the price of a share, therefore attracting new investors.

Understanding a Stock split

It increases the total number of outstanding shares by lowering the value of each share individually. While the number of outstanding shares changes, the company’s overall market capitalization and value of each shareholder stake remain constant.

Assume that you own one share of an organization’s stock. If the firm chooses a 2-for-1 split, you will receive one more share, making the total shares you own two, but each share will be worth half as much as the original. Your two shares in total would be of the same value as the one you owned before the split.

Many investors may not be interested in buying one share for $1000. But they will be more comfortable purchasing 100 shares if the same share is given for $10 per share. So when the stock price rises, an organization usually declares a stock split to decrease its per share value keeping the total market capitalization constant.

As this does not affect the fundamental value of your investment, you will not notice any significant changes in the value of your investment account other than the number of shares. 

On the other hand, it can motivate individuals who aren’t currently shareholders to invest. For example, if you could not get Apple’s share before the latest stock split due to the high price per share, you might be able to now. 

In summary, it has little impact on the company’s current shareholders. The main impact is on potential investors who are watching stock and expecting to buy a share at a full share at a lower price. It can be a potent stimulus for those investors who have been sitting on the sideline.

what are the Reasons for a stock split?

There could be several reasons; some of the major ones could be the following:

The question arises, why would a company go through all the hassle to increase its outstanding shares when it doesn’t even affect its market capitalization? 

There are several reasons. The two common reasons are:

First, a company’s stock price is generally high when it decides to split, making a standard lot of 100 shares incredibly expensive for individual investors.

Second, higher outstanding shares can mean more liquidity for the company, making trading easier and narrowing the bid-ask gap. Increasing a stock’s liquidity makes it easier for buyers and sellers to trade it. 

Traders and investors can acquire and sell firm shares without significantly impacting the stock price. This can also enable firms to repurchase their shares at a reduced cost, making a big impact on the business.

Theoretically, it should have no effect on the stock’s price, but it frequently results in renewed interest from the investor, which can boost the stock price. For example, splits by blue-chip companies are an optimistic signal for investors.

When a company’s stock price climbs to a point where many investors are priced out or when the price has increased much higher than its competitor’s shares, then this is a smart decision.

Many of the top firm’s stock prices regularly return to the level at which they previously split the shares, resulting in another split. 

For instance, Apple’s stock had been split the following times. On August 28, 2020, the shares were divided 4-for-1; on June 9, 2014, it split 7-for-1; and on February 28, 2005, June 21, 2000, and June 16, 1987, it split 2-for-1.

Example

In August 2020, Tesla split its stock with a ratio of 5:1, giving the investors an additional four shares for everyone they already owned. 

The share was trading at around $2213 at that time, pre-split adjusted. The split brought the value of a share down to approximately $498. (2213/5)

This split was done one day after they announced the sale of $5 billion worth of shares. Though it didn’t change anything about Tesla’s fundamentals, it boosted its stock price.

What Is a Reverse Stock Split?

Each outstanding share of a corporation is turned into a fraction of a share when a reverse stock split is completed. 

If a corporation declares a one-for-ten reverse split, then each of your ten shares will be converted into one single share. If you owned 1000 shares of the corporation before the reverse split, you would now hold 100 shares

Reasons

A firm may declare a reverse split to raise the trading price of its shares. 

For example, if it considers the trading price too low to encourage the investors to buy the shares or to restore compliance with an exchange’s minimum bid price criteria.

Sometimes, small owners are “cashed out” in reverse splits, meaning they no longer are owners or shareholders of the company. There are also chances of investors losing their money due to the swings in trading prices after the splits.

Flaws

There are some drawbacks to these splits. Companies attempt to artificially enhance their stock price in this way which comes with a risk of being shunned by the investors in many circumstances.

These might also be viewed negatively. If a company’s stock price has fallen very low and is at risk of being delisted, a reverse split is more likely. As a result, investors may feel that the company is in trouble and dismiss the reverse split as an accounting gimmick.

Example

On January 3, 2011, Motorola performed a reverse split with a 1-for-7 ratio. This was done to increase the market price of its shares and the liquidity and marketability of its stock. 

Following the split, stockholders would possess fewer shares of Motorola company because the number of outstanding shares would decrease. The unit price of shares was expected to rise proportionately, maintaining the overall equity value.

For example, Suppose you were holding 1000 shares of Motorola company until the close of business on January 3, 2011. In that case, the on-for-seven ratio will convert them into 142 shares of Motorola Solutions, and you would have received cash for your fractional shares. 

Stock Split FAQs

Researched and Authored by Bhuvan Zambad

Reviewed and Edited by Sakshi Uradi | LinkedIn

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