There can be a lot of attention and hype when a company decides to split their stock. It’s important to know reasons for a split, what to watch out for, and why a lot of investors misconstrue the basics of stock splits.
Starting with the mechanics of a stock split imagine holding a wooden pencil. You test your strength and decide to break the pencil in half into two pieces. Same pencil but now in two pieces, and with a 2-for-1 stock split, this is exactly what happens. The one share you have of a stock is replaced with 2 shares, and each share is worth half the price. So if a $100/share stock has a 2-for-1 split, each share will now be worth $50. There is no change in the value of the company(market capitalization), but there is just more shares trading from the 2-for-1 stock split.
So why would a company decide to split their stock? In most cases companies try to reduce the share price of the stock so that individual investors can afford to buy shares. Who can afford multiple shares of Amazon above $2,900/share?! Apple has undergone two stock splits in the last few years making it much easier for the small investor to buy shares. From a company’s point of view they are trying to expand their investor base, as individual investors are more prone to “buy and hold” for the long term.
What investor’s typically get wrong with stock splits is they think the value of the company goes up with a stock split, which can drive up the price of a stock before and after a stock split due to buyer exuberance. Again the value of the company, market capitalization, does not change with a split. If a company pays a dividend to shareholders, this will be adjusted as well to reflect the split. The other thing to beware of is reverse stock splits. This is where a company will artificially pump up their stock price to attract larger investors, institutional investors, who can’t buy a stock that is below $5 or $10 a share. In these scenarios you will see for examply a 1-for-5 split, meaning a $2/share stock will now be $10/share post-split. It isn’t a good sign a company does this, so be very careful.
As an owner of a company that undergoes a split it can be a positive sign that management are trying to expand the investor base, and by the same token, you can rightfully assume they don’t expect the stock to get any cheaper to achieve this. In the long run stock splits are a great sign of companies, and their stock, doing well in the future.
There is definately a great deal to learn about this topic. I really like all the points you have made. Kamilah Wood Langan