What is a Stock Split – Everything You Need to Know

Have you ever thought about what a stock split represents? What do “Google stock split,” “Amazon stock split,” and “Tesla stock split” actually represent? Before all, it’s crucial to understand the term “stock” and why it is so popular nowadays.

The term stock represents the shares that divide the ownership of a corporation or company in finance. The term “stocks” can also be used interchangeably with “shares,” especially in American English.

When an individual holds a lone stock share, they possess a fractional ownership of the company that is commensurate with the total number of shares accessible. Shareholders, also referred to as stockholders, commonly receive a portion of the business’s profits and gains from the sale of assets. These are distributed proportionately based on the amount each shareholder has invested.

Nonetheless, not all stocks are created equal. Various stock categories may exhibit distinct features. These are voting privileges, priority in receiving profits or liquidation proceeds, or no voting rights at all. But what exactly does a stock split entail? Let us delve into the intricacies!

What Is a Stock Split?

Stock split in the trading sector is a common thing. What positive changes can this move bring if you have heard about it? How profitable is it to the company? Splitting shares – what do you need to know about it? Let’s dive in.

A stock split occurs once a certain company grows the number of shares to increase stock liquidity. While the number of active shares is rising, the value of USD of all present shares stays as it was before. It is crucial to understand that the split isn’t the one that generally changes the net worth of one firm or corporation. According to experts, the most popular split coefficients are 2-1; 3-1. 

This means that the shareholder is expected to include 2 or 3 shares. A share split is a corporate activity where a company issues additional shares to its shareholders. This increase their total number based on the indicated odds. 

The purpose of a share split is often to lower the trading price of the shares to make them more affordable to a broader range of investors and to increase their liquidity. 

This is because most investors are more comfortable buying shares at a lower price. When the share price rises significantly, companies may choose to split their shares.

 

Many top companies regularly see their stock prices return to the levels they previously held. This leads to another division of shares. Walmart, for example, split its stake 11 times on a 2-1 basis between its stock market debut between 1970 and 1999. 

An investor who bought 100 shares in Walmart’s initial public offering would see the shares rise to 204,800 over the next 30 years. Without additional purchases. In 2020, Apple divided its shares into 4, 1.3. Before the split, each share was selling for about $540. After the break, the stock price on the open market was $135. 

An investor who owned 1,000 shares after pre-splitting would own 4,000 shares. Apple shares rose from $3.4 billion to about $13.6 billion, and market capitalization was $2 trillion. 

Understanding stock splits

Understanding the dynamics behind stock splits reveals how they can influence market capitalization. Also shows how they affect stock prices on the stock exchange, and modify the perception of a company’s value.

When companies split their stock, whether through 2-for-1 splits, 3-for-1 stock splits, or even reverse splits, they adjust the number of shares each investor holds.

For instance, an investor with 100 shares before a split could end up with 200 shares if the company opts for a 2-for-1 split, effectively doubling the number of outstanding shares without changing the investor’s stake in the company’s value.

Such corporate actions are strategic moves by a company’s board of directors to make the share price more accessible or attractive to a broader base of investors.

A high share price, like that of Berkshire Hathaway, can be daunting for individual investors, leading companies to consider stock splits to lower the price per share without affecting the overall market capitalization.

Conversely, a reverse stock split is applied when a share price is too low, consolidating shares to increase the price per share, which can also impact the company’s listing status on stock exchanges.

The decision to execute a stock split reflects a company’s desire to increase liquidity and trading activity, suggesting that a stock split increases the number of shares but keeps the total value of shares worth the same.

This move can signal to the market that the company is doing well, often leading to a temporary boost in stock prices due to increased investor interest. While the fundamental value of the company doesn’t change, the psychological impact on investors can be significant, making a stock split good news for existing and potential shareholders.

Reasons for Stock Splitting

When a share split is announced, companies often describe it as a one-time special dividend on stakes. This is not a quarterly cash dividend. It simply means that the company will split the shares by issuing additional shares. The company’s board of directors can split the shares in any ratio. For example, a stock split can be for 2-1, 3-1, 5-1, 10-1, 100-1, and so on. 

On the other hand, the price will reduce by dividing the old stock price by three after dividing the old stock by 3-1. This is because the division of shares does not change the company’s value according to market capitalization.

Why Do Corporations Go Through the Hassle and Expenses of Stock Splitting? 

There are several reasons. Initially, companies tend to split their stocks when the share price is relatively high. Additionally, a greater number of shares can result in higher liquidity, thereby promoting trading activities. 

Increasing stock liquidity makes it easier for buyers and sellers to engage in stock trading without affecting the stock price.

This can help companies purchase their shares at a lower cost. Their orders will not inflate the stock price of more liquid stocks. This could mean significant savings for some companies.

Although the stock split should not affect the stock price, it often attracts renewed investor interest, which can have a positive effect on stock prices. While this effect may decrease over time, the distribution of shares by blue-chip companies is a growth signal for investors.

Should You Buy Stock Before or After the Split?

When a company announces a stock split, its stock price usually goes up because it increases the number of outstanding shares, making it more affordable to a broader range of investors. However, trading on this information before it becomes public is insider trading, which is considered illegal. 

Insider trading violates securities laws that ensure all investors have equal access to information. It can also undermine investor confidence and the integrity of the financial system.

To prevent this, companies have strict policies governing the handling of confidential information and restricting trading by insiders. To avoid risks associated with insider trading, investors should trade based on publicly available information.