Virtually every company desires to attract as many investors as possible. The more investors you have, the more capital you can invest into the business, and the more profit you can generate. That is why the price and value of a company’s stocks matter a lot to them.
However, the worth of a company’s stocks increases as the company grows, and the increase reflects in the price of shares. Very high share prices mean that not every investor can afford the stocks. So, many companies engage in stock splits to keep their shares affordable to investors at different levels.
Here at Successfultradings, we’ll consider what a stock split is, how it works, famous examples, and every other thing you need about a stock split.
What is a Stock Split?
Simply put, a Stock Split refers to a company’s decision to divide its existing shares into more share units. With a stock split, you can increase the number of shares your company has without increasing the overall worth of the shares.
The general effect of a stock split is that it increases the number of a company’s shares outstanding and decreases the unit price of shares. In essence, the total value of a company in shares and the value of each stakeholder’s shares remain the same.
The only changes after a stock split are the increase in the number of shares outstanding and the reduction in the price of shares. You can watch this video to learn more about stock splits.
How Does a Stock Split Work?
For a better understanding of what happens after a stock split, let us illustrate with some figures.
Assume Company Z has a total of 100 shares outstanding at $60 each. That’s a total share value of $6,000. Also, say as an investor, you buy 20 units of shares of stocks from company Z; that’s a total stake of $1,200.
Now, let’s assume the company decides to do a “3-for-1” stock split, for instance. It means every share you have is divided into three units. So, while the company now has a total shares outstanding of 300 shares, you have a total of 60; that is 3 times the previous number of shares.
Remember that the total worth of the shares remains the same even after the stock split divides them into greater multiples. So, in this scenario, the 300 shares of the company will still be worth $6,000 and the 60 shares you have will still be worth $1,200.
However, notice that stock split reduces the unit price of shares. In our example, the new share price will then be $6,000 / 300; that is, $20. So, for every share of $60, you get 3 shares of $20 each after the split.
There are different ratios a company can apply to its stock split. The ratio tells you how many units a share will be split into. For instance, if a company does a “4-for-1” split, it means each share is divided into four units. The most common stock split ratios are 2-for-1, 3-for-1, and 3-for-2.
However, there are no limits to the ratio a company can apply. The major thing is that the total worth of the split shares must equal the original worth of the shares before it was split.
Below is a summary of common split ratios and how they work. Assume you have a share of company BG worth $1,000, and the company decides to split the stock. This table demonstrates the effects of the split under different ratios.
|SPLIT RATIO||PRICE BEFORE SPLIT||PRICE AFTER SPLIT|
|2-for-1||$1,000||1000/2 = $500 each, total of 2 shares|
|3-for-1||$1,000||1000/3 = $333.3 each, total of 3 shares|
|4-for-1||$1,000||1000/4 = $250 each, total of 4 shares|
|5-for-1||$1,000||1000/5 = $200 each, total of 5 shares|
|N-for-1||$1,000||1000/N = $M each, total of N shares|
Why Do Companies Split Stock?
Although stock splits do not add any direct economic value to a company, several benefits make companies consider it. Some of the major reasons are:
- To Make the Shares More Affordable
When the share price of a company becomes very high, it can scare away investors who are low on budget. It implies that only investors with high capital can afford the shares.
But when such a company splits its stock, the share price reduces without affecting its total value. As such, other investors can afford the stocks and the shares also have more potential to grow in value.
- To Enhance Stock Liquidity
Stock splits increase the number of shares a company has in circulation. This is a plus for stock traders as it becomes easier to buy and sell the stock at moderate prices.
It means that trades with that stock can be executed much more quickly and without needing so much capital too. This gives day traders the ability to maximize sharp and short market movements to make quick profits.
- To Spike Up Interest in a Company’s Stock
Most investors perceive stock splits as a sign that a company is doing well. So, when a company splits its stock, investors take it that the increase in price that warranted the split is a signal that investing in the company will be a profitable move.
Since investors love investing in companies that have prospects of high ROI, splitting stocks attracts more investors.
Also, the reduction in share price that results from stock splits attracts the attention of potential investors with lower capital. As more people become interested, the demand for the stock increases. The high demand in turn causes an increase in the price of the shares.
- To Create Room For More Growth
Due to reduced share prices and more available shares outstanding, a company’s stocks become more accessible to investors at different levels. This means they can generate more capital to expand the company or invest in massive projects.
The reduced price also gives the shares more allowance to accommodate future increases in price and value.
Famous Examples of Stock Split
#1. Apple Stock Split 2020
One of the most popular stock splits in recent times is that of the giant tech company, Apple, in 2020. Apple announced its intentions to split its stock, AAPL, on July 31, 2020. The company stated that it was a move to make its shares accessible to a wider range of investors.
The AAPL split came after the company stocks recorded a high price of well above $400 for the very first time. The rise in value was not surprising though after the company reported a profit of over $11 billion and a revenue of close to $60 billion.
This most recent split by Apple was a “4-for-1”, meaning that each shareholder got four shares for every single share they hold. According to the reports, the split applied only to shareholders who held AAPL stocks as of August 24.
Before the August 2020 split, Apple shares sold for $499.23 at market closing on Friday, 28th August, 2020. The 4-to-1 split meant that the shares sold for about $127 after the split.
History of Apple’s Stock Splits
The 2020 stock split was the fifth time Apple split its stocks since its public inception in December 1980.
- Their first split was on June 16, 1987, when the company split their stocks on a 2-for-1 split ratio.
- On June 21, 2000, Apple had its second split which was also a 2-for-1 split.
- This was followed by yet another 2-for-1 split in February 2005 as the company kept waxing stronger.
- Then, the company had its biggest split in June 2014 which was a 7-for-1 split.
From rough estimations, Apple shares would have been selling for a sky-high $28,000 per share if they have had no slit stock throughout this timeframe.
How the Apple Stock Split Influenced the Stock Market
The Apple stock split of 2020 had its impact on one of the most popular stock indices; the Dow Jones Industrial Average (DJIA). If you’re knowledgeable in the stock market, this should not be a surprise to you given that Apple is a “blue-chip” company.
The Dow Jones Industrial Average is a price-weighted index. What it means is that the companies that constitute the index are ranked by the prices of their shares.
Before the split, Apple topped the rankings on the DJIA with its share price a little below $500. But after the split, the company was somewhere within the middle of the index table. Of course, this meant that the stock became more reachable to investors that follow the DJIA.
#2. Tesla Stock Split 2020
In the same August 2020, popular electric car company, Tesla, also split its stock in a 5-for-1 ratio. According to the press release, the split applied to every stockholder on record as of 21st August, 2020 and took effect from August 31, 2020.
Before the Tesla stock split, a share of Tesla stocks sold for about $2,213. But the split brought down the price per share of Tesla stocks to about $442.
However, there has been strong evidence of growth in the company’s value after the split. On a split-adjusted basis, the share price since the split was announced in August 2020 has risen to above $800. That’s close to 200% of the price as at the time of the split, and still well above the stock price of many companies.
Because of this increase, many people expect that Tesla might be up for another stock split pretty soon. Such projections are based on the fact that Tesla’s business is considerably doing well at the moment, and the share price is still relatively high. However, investors can only keep watching as the company has not made any indications in that regard.
Reverse Stock Split
Sometimes, companies also do stock splits to directly boost the price per share of their stocks. This type of stock split is known as a reverse stock split. Reverse stock splits works directly opposite the way forward splits work.
In a reverse stock split, multiple shares are combined to make one share. For instance, in a 1-for-5 reverse split, 5 shares combine to become one share. So, if you had 5 shares of $30 each, they will become one share worth $150 after a reverse stock split.
Companies mostly do reverse stock splits when their price per share gets too low. Very low prices can affect a company’s stock performance in various ways.
First, it might put the company at the risk of getting delisted from an exchange when their share price gets below the minimum required price. This implies that it becomes harder to trade such stocks.
Again, if the share price of a company stays too low for a long time, it might be an indication of low growth potential. Of course, this is a turn-off for most investors.
So, boosting the share price via a reverse stock split may help attract more investors. If you want to learn more about reverse stock split, this video might be a helpful resource.
Below is a summary of reverse stock split and the effect of different ratios on a company stock of $1,000 each.
|NO OF SHARES||WORTH BEFORE REVERSE SPLIT||REVERSE SPLIT RATIO||OUTCOME OF REVERSE SPLIT|
|10||$300||1-for-10||1 share worth $300|
|50||$500||1-for-5||10 shares worth $50 each|
|10||$50||1-for-5||2 shares worth $25 each|
Impact of Fractional Shares on Stock Split
With the recent introduction of Fractional Shares trading on many platforms, it is reasonable to assume less and less companies will resort to stock splits as a way to attract new investors.
Nowadays, you could become an owner of NFLX fractional shares for less than the price of a movie ticket .
Or you could easily acquire fractional shares of AMZN for as little as what you pay for your yearly prime subscription.
This is makes it less likely that the big expensive stocks will risk diluting the value of the current shareholders.
Here is our full article on how to buy Fractional shares on Webull, one of the first brokers to offer this feature on a large scale of stocks.
Both forward and reverse stock splits do not affect the overall worth of a company’s shares outstanding. You can learn the differences between forward and reverse stock split here.
As an investor, you might need to watch out closely for the causes and implications of a stock split for your company of interest. This will help you make good investment decisions and stay on course for better returns on investments.
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