What is a stock split?
The stock split. Sometimes it feels like much ado about nothing; just corporate management rebalancing shares and prices, with no real impact on company value. But there’s always a reason behind each split. Read on.
Key highlights:
- A stock split is when a company divides the existing shares of its stock into multiple new shares to increase the stock's liquidity.
- The ratio of a stock split can vary but the most common are 2:1 and 3:1, with some stock splits going all the way up to 32:1.
- A reverse stock split consolidates the number of shares; a company decides to decrease the number of shares outstanding, increasing the price of each share.
Names like Tesla (TSLA) and Apple (AAPL) have completed a stock split in recent years. A company decides to divide the share price by some factor, which subsequently multiplies the number of shares available by that factor. Let's dive deeper into a split’s functionality and why stock splits occur.
What is a stock split?
A stock split is when a company divides the existing shares of its stock into multiple new shares to increase the stock’s liquidity. The most common stock split ratio is 2:1 or 3:1, which means that for every share a person holds, they’ll have two or three times as many shares after the split occurs.
Once a company's stock has split, the number of outstanding shares will increase, but the value of each shareholder's stake in the company and its market capitalisation will stay the same.
How do stock splits work?
A stock split works by the company issuing additional shares to shareholders, increasing the total by a specific ratio.
For example, let’s take a hypothetical company called Maverick.
Maverick has 1m shares traded at $1,000 each and a $1b market cap. If it undergoes a 4:1 stock split, it would have 4m shares, trading at $250 each. The company is still worth $1b and its shareholders have the same value in their account, but the number of shares they now own is 4x greater.
What is a reverse stock split?
A reverse stock split is the opposite: instead of increasing the amount of shares, the company decreases the number, increasing the price per share.
This typically happens with low-value stocks, like those under $5 per share. Certain institutions, funds and indexes are not allowed to invest in them, as defined in their mandates. By increasing the price per share, reverse stock splits can open certain stocks up to a larger pool of investors.
Moreover, certain indexes or exchanges have price limits. A reverse split ensures stocks can avoid delisting.
Let's look at an example of a reverse stock split:
$MVK has 100m shares trading at $0.50 each. It’s a US$50m company.
It completes a 1:10 reverse split. Suddenly, it has 10m shares outstanding at $5 each but its market cap remains at US$50m.
Why do companies do a stock split?
There’s an argument that a lower stock price makes the stock more accessible. Consider that not all investors have access to brokers like Stake, which offer the opportunity to buy fractional shares with smaller amounts, regardless of any nominal price.
Sometimes it seems like these events happen for no reason and have no real impact on the company’s value. But there is a reason behind every split or reverse split.
One reason is to increase liquidity. More shares outstanding leads to more shares being traded at each price level. Deep liquidity is a positive for a stock and can attract a more diverse range of investors and create renewed investor interest.
Advantages of a stock split
If large market cap stocks like Amazon, Tesla and Apple are splitting their stock for existing shareholders, then there must be some benefits. Find the advantages of a traditional stock split below:
By increasing the number of shares outstanding, there can be greater liquidity for the company's stock.
With higher liquidity, purchasing the stock becomes easier which in turn helps companies repurchase their shares at a lower price.
Stock splits can be a bullish signal for investors, with new investors showing interest and this having a positive effect on the price of the stock.
Disadvantages of a stock split
Share prices don't always go the way a company had hoped. Here are some disadvantages of stock splits:
Many investors could buy a stock after it splits looking for short-term gains, which can lead to increased volatility as they aren't committed to the long-term prosperity of the company.
It’s not always the case that a stock will come out on top after a stock split, and instead of seeing an increase in price, the share price could decrease.
Recent stock splits
Some of the largest companies in the world have gone through a stock split, like in the following examples.
Apple 4:1 stock split (2020)
In late July 2020, Apple announced a 4:1 stock split. This meant that those holding positions in Apple received 4x the number of $AAPL units they owned when the split occurred on 28 August 2020. Consequently, the AAPL share price at the time was divided by four.
Tesla 5:1 stock split (2020)
In early August 2020, Tesla announced a 5:1 stock split which occurred later that month – in fact, on the same split date as Apple above. Around the time of the announcement, the Tesla stock price was at $1,300 before surging to a high of $2,000 a share. From 31 August 2020, Tesla holders owned 5x the number of $TSLA units they previously had, at the new split-adjusted price.
Tesla 3:1 stock split (2022)
On 5 August 2022, Tesla announced their second stock split in as many years, this time with a ratio of 3:1. The electric vehicle stock began trading on the split-adjusted price of $302.36 on 25 August 2022.
What happens to my shares if they undergo a stock split?
During the splitting of a stock, you keep your existing shares and are credited with additional shares where the value is reduced in price accordingly.
For instance, using a forward stock split with a 3:1 ratio, if you owned 1,000 shares with a market value at $45 before the split, you would now have 3,000 shares at $15 each, with the same underlying value.
What ratio sizes can a stock split be?
The most common stock split ratios are 2:1 and 3:1.
But as seen above, in 2020 we saw Apple split their stock with a 4:1 ratio, and Tesla’s split was a 5:1 ratio.
In the same year, Equinix (EQIX) had a 32:1 stock split, proving that ratio sizes can vary.
Does a stock split change the value of my positions?
Irrespective of the split ratio, the total value of positions will remain the same as the market close price the day prior to the stock split. What will change is the number of positions you own. Example 100 shares at $4/share (total value $400) become 400 shares at $1/share (total value still $400).
