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The inside scoop on stock splits – what investors need to know

After Alphabet’s high profile move, we look at what investors need to know about stock splits.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

The financial newsreel has seen a lot of focus on Alphabet's stock split at the start of February. It echoes similar moves by Tesla and Apple back in 2020. Talk ranged from retail investors ‘pouring into’ the stocks following the move, to the additional boost to Elon Musk’s already substantial wealth.

But for the everyday investor it’s not immediately clear what a stock split is, why they’re done or whether they actually matter. We’d like to fix that.

This article is not personal advice, if you’re unsure whether an investment is right for you, seek advice. All investments can fall as well as rise in value, so you could make a loss.

So, what is a stock split?

The name’s on the tin with these. 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.

Whether or not to split shares is up to the company – Apple’s actually split its stock five times since it listed. The latest one on 28 August 2020 was done on a four-for-one basis, meaning each existing share was swapped for four new ones.

Why do companies do it?

A common misconception with stock splits is they’re done to raise money. Usually when a company creates new shares, it’s done for this very reason.

But stock splits are actually done 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.

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.

But if it’s a purely skin deep change, why do companies bother?

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 small 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 $479,500. 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.

How do they affect existing investors?

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:

1. Stock splits create new shares by splitting old shares into smaller new shares, for example on a two-for-one basis

2. They reduce the share price, but:

3. Stock splits don’t change the intrinsic value of a company or your shareholding

Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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