A stock split can be a good thing, but it's not always clear how it affects you. The main benefit is that it can make the stock more affordable for individual investors.
Stock splits typically happen when a company's stock price gets too high, making it harder for small investors to buy shares. This can lead to a decrease in the stock's price, but the total value of the company remains the same.
For example, if a company splits its stock 2-for-1, you'll get two new shares for every one you already own. This can be a good thing if you think the company's stock price will continue to rise.
However, some investors worry that a stock split can be a sign of a company's financial struggles, and that the split is a way to artificially boost the stock price. But this isn't always the case, and many successful companies have split their stock multiple times.
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What Is a Stock Split?
A stock split is a corporate action where a company divides its existing shares into a larger number of shares. This increases the total number of shares outstanding, making each share more affordable and attractive to investors.
The main purpose of a stock split is to make the stock more accessible to a wider range of investors, including those with smaller budgets. For example, if a company's stock splits 2-for-1, a shareholder who owns 100 shares will now own 200 shares, each worth half the original price.
Stock splits can also be used to boost investor confidence and sentiment, as they can be seen as a sign of a company's growth and financial health.
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What Is a Stock Split?
A stock split is a corporate action that increases the number of shares outstanding by dividing existing shares into more shares of a smaller par value.
Stock splits are typically done to make the stock more affordable and attractive to individual investors.
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The par value of a stock is the minimum amount of money that must be raised when issuing new shares.
For example, if a company has a par value of $100 per share and splits it 2-for-1, the new par value would be $50 per share.
Stock splits do not change the total market value of the company.
In a 2-for-1 stock split, the number of shares outstanding would double, but the total market capitalization would remain the same.
Stock splits can be a way for companies to signal confidence in their future prospects.
Companies often split their stock when the price has risen significantly, making it more expensive for individual investors to buy.
A stock split can also make it easier for companies to issue new shares to employees or investors.
For instance, if a company wants to issue 10,000 new shares to its employees, a 2-for-1 stock split would make it easier to do so.
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Example of a Stock Split
Nvidia underwent a 10-for-1 stock split in May 2024, meaning investors now hold 10 shares for every one they previously owned.
This split doesn't change the total value of investors' holdings or the company's market capitalization, which remained at just over $2.5 trillion.
NVDA's market capitalization represents 2.5 billion shares outstanding with a market price of about $1,000 per share before the split.
After the split, there were 25 billion shares, with an initial value of around $100.
The split makes Nvidia stock more affordable for everyday investors, who have been excited about the stock in recent years.
Nvidia's stock chart appears unchanged after the split, with the share price adjusted to match each split afterward.
Most brokers now offer flat fees for commissions or no commissions at all, making the old strategy of buying before a split less advantageous.
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Pros and Cons
A stock split can have both positive and negative effects on a company and its investors. Here are some key points to consider:
A stock split can make a company's shares more attractive to small investors by lowering the share price, making it more affordable to buy and own shares.
More shares in the market can lead to increased liquidity, which can make it easier for investors to buy and sell shares without affecting the price.
A stock split can also boost investor sentiment and confidence, as it may signal that the company's management is confident in its future performance.
In fact, a Columbia University study found that stock splits can generate "abnormal returns" and lead to better future earnings growth for up to two years after the split.
On the other hand, a stock split can create a misleading perception of increased value or growth, which may not be reflected in the company's actual financial health.
A stock split can also cause short-term volatility in stock prices, which may not be desirable for investors.
Additionally, a stock split doesn't improve the company's actual valuation or financial health, it's just a change in the number of shares outstanding.
Here are some of the key pros and cons of a stock split:
- Lower share price makes it more attractive for small investors
- More shares in the market can lead to increased liquidity
- Can boost investor sentiment and confidence
- Can signal management's confidence in the company’s future performance
- Can make employee stock options more attractive
- May create a misleading perception of increased value or growth
- Can cause short-term volatility in stock prices
- Doesn't improve the company's actual valuation or financial health
- Although the total earnings remain the same, earnings per share gets diluted, which can be perceived negatively
Investor Considerations
Historically, bullish outcomes tend to follow stock split events, often in the form of higher earnings expectations and sometimes earnings growth.
Stock splits can be a self-fulfilling prophecy, but this tactic is now less reliable due to many traders figuring out the play.
Some active traders used to buy a stock a few weeks before the split and sell it just a few days before the actual split, but this is no longer a lucrative strategy.
If a split might affect a company's inclusion (or exclusion) from an index, there may be opportunities to pay attention to.
For Investors?
For investors, it's essential to consider the potential impact of a stock split on a company's stock price. Historically, stock splits have been followed by bullish outcomes, including higher earnings expectations and sometimes earnings growth.
Some traders used to exploit the pre-split buying and selling strategy, but it's no longer a reliable tactic. This outdated approach may not be worth the time, effort, and risk involved.
A stock split can, however, create opportunities if it affects a company's inclusion in or exclusion from an index. This is something to pay attention to, even if it's not a guarantee of success.
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Do Mutual Funds Like Individual Shares?
Mutual funds can engage in splits like companies, although it is less common. This is usually done to make the price more accessible.
A mutual fund might do this to increase the number of its shares outstanding while simultaneously decreasing the price per share by the same factor.
The rationale for a mutual fund engaging in a split is the same as for companies: to make its price more accessible.
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Ratios and Performance
Stock splits can take many forms, but the most common are two-for-one, three-for-two, and three-for-one. An easy way to determine the new stock price is to divide the previous stock price by the split ratio.
Typically, a stock will grow by between 25% and 30% in the first 12 months after a split. This compares very favorably with the S&P 500’s average growth of between 10% and 12%.
A three-for-two split, for example, would result in a new stock price of $40 if the previous price was $60.
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Common Ratios
Stock split ratios are often 2:1, 3:2, and 3:1. These ratios are frequently used by companies to adjust their stock prices.
A two-for-one split is a common ratio, where one share is divided into two. This type of split can significantly lower the stock price.
The new stock price after a split can be calculated by dividing the previous stock price by the split ratio. For instance, if a $60 stock undergoes a three-for-two split, the new price would be $40.
Amazon and Alphabet split 20-for-1 in 2022, while Apple split 4:1 in 2020 and 7:1 in 2014.
Company Performance Post
Historically, stock splits tend to be good for share prices, with the stock that has split outperforming the market in the 12 months after a split.
On average, a stock will grow by between 25% and 30% in the first 12 months after a split, which compares very favorably with the S&P 500's average growth of between 10% and 12%.
The interest generated by a stock split and the greater accessibility of a lower price are key factors contributing to this growth.
Apple's 4-1 stock split on August 28, 2020, reset the share price to $124, and by August 27, 2021, Apple's stock had risen to $146, a 16% return.
Not all stock splits result in significant growth, however. Consider Tesla's 3-1 stock split on August 24, 2022, which saw shares trade for $288 per share at the time of the split but had fallen to $238 per share by August 25, 2023, an 18% loss.
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Company Decisions
Companies split stock for several reasons. Affordability is a key factor, as a lower share price makes shares easier to acquire, especially for smaller investors.
A lower share price can also make it easier for investors to use option contracts for risk management and potential income on shares they own.
Index inclusion is another reason why companies split stock. Some stock indexes, like the Dow Jones Industrial Average, are price-weighted, meaning a company must have a price within a certain band to be included.
Some companies see a stock split as a sign of confidence in their ability to generate profits and growth in the future.
A stock split can be a win/win proposition for companies, making shares more accessible to investors and signaling confidence in the company's future prospects.
Here are some examples of companies that have split stock and seen positive results:
Note: The share prices listed are examples and may not reflect the current share price.
Key Takeaways and Findings
A stock split can seem like a straightforward concept, but there's more to it than meets the eye. Companies divide their shares to boost liquidity and make share prices more attractive.
The most common stock splits are two-for-one or three-for-one, where stockholders get two or three shares for every share held. This doesn't add real value to the company or the shares.
The total dollar value of a shareholder's investment remains the same after a stock split. This is because the split doesn't change the company's fundamentals.
Stock splits can be a sign of a company's health, but they don't guarantee future success. In fact, research has shown that stock splits don't affect the value of shares.
Here are some key facts to keep in mind:
- A stock split increases the number of outstanding shares, and the share price adjusts in proportion to the change.
- A stock split won't change a company's fundamentals, but it makes shares more affordable for smaller investors.
- Stock splits are generally bullish in the short term, but the exact reason remains a mystery.
- Stock splits don't affect the value of shares that you hold in a company.
- A stock split isn't a reliable indicator of whether a stock's value will increase or decrease.
Some companies, like Amazon, have even outperformed the S&P 500 after a stock split. However, this is not always the case, as seen with Shopify, whose share value dropped significantly after a stock split.
Frequently Asked Questions
Is it best to buy stock before or after a split?
Buy stocks before a split to potentially avoid the initial price drop that occurs after a split, when the stock price adjusts to the new ratio. However, buying after a split can be a good option if you're looking for a lower entry point and are willing to ride out the initial price adjustment.
Is there a downside to stock splits?
Yes, there are potential downsides to stock splits, including damage to a company's reputation and the risk of delisting or removal from mutual fund holdings.
Who benefits from a stock split?
Smaller investors may benefit from a stock split, as it can make the stock more affordable. A stock split can also signal a company's confidence in its future prospects, attracting more investors.
What is the average gain after a stock split?
Stocks typically grow by 25-30% in the first 12 months after a split, outperforming the S&P 500's average growth of 10-12%
Will stock prices go up after split?
Stock prices will remain the same after a split, as the value of the shares is divided, not increased. However, a split can make the stock more attractive to investors, potentially leading to increased trading activity and price movement.
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