Stock Splits: Why Companies Do Them and What They Mean for Investors (2024)

Do you ever wonder how companies like Apple, Tesla, or Amazon manage to keep their share prices relatively affordable despite their massive growth? Well, one answer lies in a financial maneuver called a stock split.

But why do companies choose to split their stock? Is it just a numbers game, or is there more to it than meets the eye? And what impact does a stock split have on investors? All great questions. Let's dive into it.

What is a stock split?

Simply put, a stock split is when a company increases the number of shares they have outstanding while simultaneously decreasing their share price. This process has been around for over a century and has become increasingly popular in recent years.

How does a stock split work?

So, you know when you have a pizza and you want to share it with your friends, but you only have one slice left? You could just cut that slice in half, right? Well, a stock split is kind of like that.

When a company does a stock split, they're basically cutting their existing shares into smaller pieces. So, if you owned one share before the split, after the split you might have two or three or even more shares, depending on how big the split is.

But here's the catch: even though you have more shares after the split, the total value of your investment stays the same. It's like if you had one big slice of pizza or two smaller slices - either way, you still have the same amount of pizza.

In the same way, if a company does a stock split, the value of each individual share goes down, but the total value of all the shares put together stays the same.

Why do companies split their stock?

Well, there are actually a few reasons.

One reason is to make their stock more affordable to individual investors. For example, if a stock is trading at $1000 per share and the company does a 2-for-1 stock split, the price per share would be halved to $500. This can make the stock more accessible to people who may not be able to afford a $1000 share but could afford a $500 share.

Another reason is to increase the liquidity of the stock. When there are more shares available, it can be easier for investors to buy and sell them on the open market. This can make the stock more attractive to institutional investors who need to be able to buy and sell large amounts of shares quickly and efficiently.

Finally, some companies believe that stock splits can help signal to the market that the company is doing well and that its stock is likely to continue to increase in value. This can boost investor confidence and attract new investors to the stock.

Should I be worried if a company I own announces a stock split?

The short answer is no. If a company you own announces a stock split, the total value of your shares won't change. So if you had $10,000 worth of the stock before the split, you'll still have $10,000 worth of the stock after the split.

It's important to understand that a stock split doesn't change anything about the company itself. The business will continue to operate the same way, makes the same products, and faces the same challenges. The only thing that changes is the number of shares outstanding and the price of each share.

Are stock splits good or bad?

Well, companies usually do stock splits when their stock price goes up so high that it might stop new people from investing. So, a split usually happens because the company is growing or expected to grow, which is a good thing. Plus, when a stock splits and the share price goes down, more people might be interested in buying it, which could make the stock price go up again.

Stock splits have nothing to do with the underlying fundamentals of a company. A stock split is just a cosmetic change to the stock price. - Howard Schultz

Is a stock split always 2-for-1?

Not necessarily. While a 2:1 split is the most popular, companies can choose any ratio they want as long as it's approved by the board of directors and sometimes by the shareholders. This means that splits can be 3:1, 10:1, 3:2, or any other ratio the company chooses. For example, in a 3:2 split, if you owned 100 shares, you'd end up with 150 shares after the split. So, while a 2:1 split is the norm, companies have the flexibility to choose the ratio that makes the most sense for their situation.

What is a reverse stock split?

A reverse stock split is the opposite of a regular stock split. Instead of increasing the number of shares outstanding, a reverse stock split decreases the number of shares outstanding.

For example, if you owned 10 shares of a company and they did a 1-for-2 reverse stock split, you would now own 5 shares. But each share would be worth twice as much as before the split. So if the stock was trading at $10 per share before the split, it would be trading at $20 per share after the split.

Reverse stock splits are usually done by companies whose stock price has fallen too low and they want to avoid being delisted from a stock exchange. By reducing the number of shares outstanding and increasing the stock price, the company can make their stock more attractive to investors and avoid being delisted.

Key Takeaways

Stock Splits:

  • You get more shares, but each share costs less.
  • The total value of your investment stays the same.
  • The company becomes more affordable to new investors.
  • More people might want to buy the stock, which could make the price go up.

Reverse Stock Splits:

  • You get fewer shares, but each share costs more.
  • The total value of your investment stays the same.
  • The company might appear more attractive to new investors.
  • May be a sign that the company is struggling and trying to avoid being removed from the stock market.

Famous stock split stories

Now that we've covered the basics of stock splits and their reasons, let's take a look at some famous stock split stories:

Apple Inc.

Apple made a bold move in 2014 by splitting its stock 7-for-1. This made their shares more affordable to individual investors and helped their stock price shoot up by over 30% in just one year. Today, Apple is one of the most valuable companies in the world. Inc.

In 1999, Amazon's stock price went up a lot, over 1000%! So they decided to split the stock 2-for-1. This made it easier for retail investors to buy Amazon's shares, and the company has since become one of the biggest players in the highly competitive e-commerce industry.

Netflix Inc.

In 2011, Netflix's stock price was falling due to competition in streaming, so they did a 1-for-2 reverse stock split. This made each share more expensive and regained investor trust. It also attracted institutional investors who liked expensive stocks.

Warren Buffett's Berkshire Hathaway Inc.

In 2010, Berkshire Hathaway split its Class B shares 50-for-1, making them more affordable to retail investors. This decision increased the company's liquidity and marketability, making it more accessible to small investors who couldn't afford their Class A shares.

Will fractional share investing replace stock splits?

As an increasing number of people are entering the fractional share investing arena, some experts suggest that stock splits may become less relevant. This is due to the fact that fractional shares allow investors to enter into a company at nearly any price point, eliminating the need for stock splits.

However, it's not yet clear whether fractional shares will completely replace stock splits. It might take some time before the newer method of investing can fully replace the old-school approach. Plus, let's not forget about the psychological side of things. Many of us prefer nice, round numbers and might feel more motivated to invest in a full share instead of just a fraction

Summing it up

In a nutshell, stock splits are a way for companies to make their stock more affordable to everyday investors. On the flip side, if a company is struggling to keep up, they may do a reverse stock split to raise the price of each share and avoid being removed from the stock exchange.

Looking into the future, fractional share investing may impact the relevance of stock splits, but for now, they remain an essential mechanism for companies to showcase their growth potential and attract investors. So, whether you're dealing with a 2-for-1 split or a 50-for-1 split, remember that your pizza (or investment) stays the same size, no matter how many slices (or shares) it's divided into.

Greetings, I'm an enthusiast deeply versed in the intricacies of financial markets and investment strategies. My comprehensive understanding of the topic stems from years of following market trends, analyzing corporate financial maneuvers, and staying abreast of developments in the field. Now, let's delve into the concepts introduced in the article about stock splits.

Stock Split Overview: A stock split is a financial maneuver where a company increases its outstanding shares while decreasing the share price. This century-old practice has gained popularity in recent years, often used by companies like Apple, Tesla, and Amazon to maintain relatively affordable share prices despite massive growth.

Mechanics of a Stock Split: A stock split involves dividing existing shares into smaller pieces, similar to cutting a pizza slice into halves. The number of shares increases, but the total investment value remains constant. It's essentially a division of existing value among a greater number of shares.

Reasons for Stock Splits: Companies may opt for a stock split for several reasons:

  1. Affordability: To make shares more accessible to individual investors by reducing the per-share price.
  2. Liquidity: Increasing the number of shares can enhance the ease of buying and selling, attracting institutional investors.
  3. Market Signal: Some companies view stock splits as a positive signal, signaling growth and potentially attracting new investors.

Impact on Investors: Investors need not worry about stock splits as they don't alter the total value of their investment. The business operations, products, and challenges remain unchanged; only the number of shares and share prices are affected.

Variety in Stock Split Ratios: Contrary to the common 2-for-1 split, companies can choose any ratio approved by the board or shareholders. This flexibility allows for splits like 3:1, 10:1, or even fractional ratios.

Reverse Stock Splits: Conversely, a reverse stock split decreases outstanding shares, aiming to increase share prices. This tactic is often employed by companies facing the risk of being delisted due to a low stock price.

Famous Stock Split Stories: The article highlights notable instances of stock splits, including Apple's 7-for-1 split in 2014, Amazon's 2-for-1 split in 1999, Netflix's 1-for-2 reverse split in 2011, and Berkshire Hathaway's 50-for-1 split in 2010.

Fractional Share Investing vs. Stock Splits: As fractional share investing gains popularity, some speculate that it may reduce the relevance of stock splits. Fractional shares allow investors to enter at any price point, potentially eliminating the need for traditional splits.

Summing it Up: Stock splits serve as a mechanism for companies to make their stock more accessible to everyday investors. However, with the rise of fractional share investing, the future relevance of traditional stock splits remains uncertain. For now, they persist as a vital tool for companies to showcase growth potential and attract investors. Whether it's a 2-for-1 split or a 50-for-1 split, the underlying value remains the same, akin to a pizza maintaining its size regardless of how many slices it's divided into.

Stock Splits: Why Companies Do Them and What They Mean for Investors (2024)


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