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Stake Academy Wall St: Stock Split

There’s been a lot of talk about stock splits amongst U.S. companies this year, but what exactly are they?

How many slices do you want in your pizza? At the end of the day it doesn’t matter how you cut it, because it doesn’t change the actual size of the meal. You just have more or fewer slices to share.

The same goes when stock splits and reverse splits occur. A stock split results in more slices (more shares), but your amount of pizza (cash balance) remains the same. When reverse splits occur, you have fewer slices (shares) but again, the amount remains the same.

So let’s dive in and find out more about these liquidity events.

Going Deeper

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.

Companies like Tesla, Apple and even GameStop have all gone through splits in the past year. Splitting happens when companies decide to divide the share price by a certain number, which ends up increasing the number available.

For example, let’s take a hypothetical company called Maverick.

Maverick has 1 million shares traded at $1,000 each and has a $1b market cap. If it undergoes a 4-to-1 stock split, it would have 4 million shares, which trade at $250 each. The company is still worth $1b and all its shareholders have the same value in their account, but the number of shares they now own is 4 times greater.

Why Do Stock Splits Happen

One of the reasons companies decide to undergo a stock split is to increase liquidity. More shares outstanding lead to more shares being traded at each price level. Liquidity is a positive factor for a stock and can attract a greater number of investors.

Some analysts say that a lower share price makes stocks more affordable. After all, a smaller pizza slice is easier to bite, right? Consider that not all investors have access to brokers like Stake, which offer the opportunity to buy fractional shares, regardless of any nominal price.

Reverse Splits

On the other hand, there are reverse splits. The company decreases the number of shares outstanding and increases the price of each share in the same proportion.

For example:

Let’s say Maverick has 100 million shares traded at 50 cents each. The company is worth 50 million in total.

If the company undergoes a one-to-ten reverse split, it will have 10 million shares outstanding, worth $5 each. But its market value remains at $50 million.

Again, Why?

This usually happens with low-value stocks; those that cost less than five dollars. Certain institutions are not allowed to invest in penny stocks, as these types of companies are usually called. Reverse stock splits make certain stocks accessible to a larger group of investors.

In addition, certain indices or exchanges have minimum price limits for listed stocks. A reverse split ensures that companies can avoid the risk of having to go private.

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When you invest, your capital is at risk.