Stock Splits
What is a stock split?
A stock split is when a company chooses to split existing high value shares into a larger number of lower value new ones. The important thing to note here is that your share of the overall company remains the same, it’s just divided into more units.
Stock splits are more common than you might think. The tech-giant, Amazon, has split its stock three times in its history. The latest one was announced in March 2022 on a 20:1 basis, meaning each existing share was swapped for 20 new ones. Other big-tech names such as Apple and Tesla have also carried out stock splits in the past.
All investments can fall as well as rise in value, so you could make a loss.
Stock split example
Let’s say a company has a market capitalisation of £200,000, which represents 200,000 shares of £1 each. Following a two-for-one stock split, there would be 400,000 shares worth 50p each. The market capitalisation is still £200,000. But the price of each individual share has halved.
Why do companies split stocks?
A common misconception with stock splits is that they’re done to raise money. Usually when a company creates new shares, it’s done for this very reason.
But stock splits are carried out to try and lower the price of shares. They don’t increase the share capital (number of shares multiplied by the share price) of a company, because the value of each share is split too.
Dividing the shares into smaller units can increase demand for the shares. This makes sense when you think about it – if the price of an individual share is say £500, then an investor with £750 to spend will only be able to afford one share. They might want more than that, so let’s say the company does a two-for-one split, making the shares £250, this investor can afford to buy three shares.
Lower share prices are also useful when it comes to remunerating staff with share options. A company might want to give a junior member of staff a bonus in shares worth a few thousand dollars. But if the share price is too high it can’t do that very easily.
In extreme cases, a high share price can also make mergers and acquisitions more difficult. A class shares in US insurance giant and investment conglomerate Berkshire Hathaway are priced at $409,460. If the group wanted to buy out a company for $1,200,000, it would have to use a mixture of cash and shares to do so – even if it would rather pay entirely in shares. That’s because its shares can’t be broken down small enough.
What is a reverse stock split?
A reverse stock split is the opposite to a standard stock split. And, the same can be said for the reasons behind carrying one out.
Companies might want to reduce the number of shares in issue to increase the same price for the remaining ones. The reasons for this can vary. It could be to avoid delisting from a stock exchange with a minimum bid price, or to make the shares seem more attractive to investors, for example.
Is a stock split good?
A stock split is neither good or bad.
The overall value of your shares won’t change, apart from the usual market movements which can see share prices fall as well as rise. The only discernible difference will be that the number of shares you own has gone up. It’s as if someone gave you a slice of a cake, insisted on cutting your slice in two, but let you keep both halves. The whole still has the same amount of calories – it’s still the same cake.
A little extra demand for the shares might make a slight difference to the share price, and the split has probably made life a little easier for management, but really nothing has changed. You own the same amount of the same company. You should treat your investment as you did before.
The key things to remember are:
- Stock splits create new shares by splitting old shares into smaller new shares, for example on a two-for-one basis
- They reduce the share price, but:
- Stock splits don’t change the intrinsic value of a company or your shareholding