What is a Stock Split?

by | Nov 2, 2020 | Financial Planning

Stock splits have been quite popular in the back half of 2020.  Plenty of large, publicly traded companies have announced splits over the last few months.  Names everybody will recognize – Apple and Tesla just to name a couple. If the high price of these names has prevented you from buying in the past, new investors may be ready to buy in after seeing the price split.

What Are Stock Splits?

When a company takes it’s current number of stock shares and splits them into more shares, that is called a stock split. Stock splits DO NOT affect the total value of your shares.  You simply have MORE shares for the same value.

For instance, if one share at $100 was split into two shares, each share would be worth $50 – still equaling $100 total.

The Math Behind Stock Splits

Think about a nice, warm pie (stick with us here). Say you have a normal, apple pie that has eight slices. Each of these slices makes up a share of a company. If that company decides to do a stock split, that means that each slice of apple pie will be further divided.

If two of those slices are yours and a 2-for-1 stock split is announced, those two slices will be split into 4 smaller total slices. You don’t actually have MORE pie, just more slices. The amount has just been divided up more. This allows less-hungry investors to grab a smaller slice of apple pie, whereas before they’d have to take a whole slice if they wanted in on the pie.

Stock splits can occur in a number of different ways: 2-for-1, 3-for-1 and 3-for-2.

If you’re thinking, what the heck does that mean?  Bear with us.  The math is actually pretty straightforward.

2-for-1: If you owned one share before the split, now you own two.

3-for-1: If you owned one share before the split, now you own three.

3-for-2: For every two shares you owned before the split, you now own three.

Who Benefits From Stock Splits?

New Investors

If you’re used to buying stocks with lower overall prices per share, stock splits can be very appealing. Stock splits help those investors buy into popular companies at lower share prices. You may not have been able to invest in a company whose stock prices sit at around $600 per share, but when the stock is split and you can obtain a few at, say, $100 a share – this may become more doable.

Current Investors

After a split, you will own more shares. However, the total value of your investment will not have changed.

For example, if you owned one share that was worth $200 and a 2-for-1 stock split occurs, you now own two shares worth $100 each- for a total value of $200.

Stock splits can benefit current investors, though by attracting new investors to the company pushing the stock price higher. There’s no guarantee this will happen, but the opportunity for higher stock prices following a split is there.

Publicly-Traded Companies

A company wouldn’t choose to do a stock split if it didn’t benefit them as well. So how exactly does a stock split benefit the publicly-traded company?  Here’s how:

Higher stock prices are almost always a good thing for a publicly-traded company.  Potentially one of the only downsides would be deterring investors when the price gets TOO high for them to buy shares. Stocks with extremely high prices per share can make the stock less-attainable for the everyday investor.

That’s why stock splits can be appealing for companies, because they allow more investors to buy shares at more affordable prices. Announcing a stock split can serve as good publicity for the company and drum up interest in the stock itself.  From a marketing standpoint, stock splits can be effective. A recent NASDAQ report indicated that simply announcing a large cap stock split increased stock value by 2.5 percent.

While stock splits don’t automatically add any real value to your investments, it adds the potential opportunity for future growth.  Stock splits can be an exciting opportunity that makes pricey stock shares more attainable for the everyday investor.

Buying a company simply because they split their stock might not be a good enough reason, though.  For this reason, you should always consult your investment advisor or financial planner before making any investment decisions.  If you don’t have an advisor, we would be happy to speak with you!  Click here to schedule an initial call with our team.


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