In a stock split, a company increases its share count. This method lowers share prices while maintaining their value. A stock split boosts share trading volume. Companies often split shares in half or three quarters. This strategy is often used to boost stock price appeal. An investor may buy 100 $10 shares instead of one for $1,000.

A 2-for-1, 3-for-1, or 100-for-1 split ratio is up to the board. Following a 3-for-1 stock split, the share price would be one-third of the pre-split price. After a split, the share price adjusts.

Stock Splits Example

Apple (AAPL) split its stock in half in August 2020. Apple shares were worth $540 before this split. By dividing the pre-split share value by four, each new share was worth $135 after splitting.

Imagine owning 1,000 Apple shares before the split. Your shares would rise to 4,000 after the split. Even though you own more shares, your holdings are worth the same. Apple stock rose from 3.4 billion to 13.6 billion after the split. This massive share increase did not affect Apple's $2 trillion market value.

Apple has split stocks before. They had done this seven times before 2020—twice in 2005, twice in 2000, and once in 1987. Due to stock splits, a 1987 Apple share would be 224 by 2020. Multiplying each split ratio by 4 yields 7 times 2 times 2 times 2.

Reverse Stock Split

Simply put, a reverse stock split reduces a company's share float. If a company announces a 1-for-2 reverse stock split, you would own five shares instead of 10. The total value of your investment remains unchanged. Imagine starting with $40 in 10 $4-valued shares.

After the reverse stock split, each of the five shares you now hold would be valued at $8, keeping your total investment value unchanged at $40. The idea behind this maneuver is not to alter the investor's absolute value but to adjust the number of shares in circulation.

Impact of a Stock Split on Shareholders

When a company undergoes a stock split, the total value of your investment remains unchanged. The primary change you’ll notice is in the quantity of shares in your portfolio. Essentially, if you had one share worth $100, after a 2-for-1 stock split, you'll have two shares, each worth $50. The total investment value remains the same at $100.

For current shareholders, this doesn't significantly alter ownership stakes. You might own more shares post-split, but their price is adjusted to half, maintaining the overall balance of your investment. On the other hand, stock splits can appeal to potential new investors. For instance, if Tesla's shares were too expensive for some investors before its split, the reduced price per share post-split might make them more accessible.

Furthermore, the affordability of shares after a stock split can attract more buyers, potentially temporarily driving up the stock’s price. This can benefit existing shareholders. However, to realize long-term gains, holding onto these shares over an extended period is generally advised, as the initial bump in value is often short-lived.

Why Companies Opt for Stock Splits?

Amanda Holden, a former investment counselor and founder of Invested Development, points out that these splits are often part of a company's strategy to achieve specific objectives.

A stock split history may be considered if a company's share price becomes unsustainable. The high price may deter investors from buying a 100-share lot. By dividing stock, the company expands its investor base.

Stock splits increase share availability. One common goal is to enhance the stock's liquidity. The stock split history and lower per-share price will allow more investors to buy the company's shares. A $500 share may be too expensive for some investors, but $125 after the split is more affordable. Enhanced liquidity makes it easier to trade the stock, benefiting both buyers and sellers. A more liquid stock can also aid companies in repurchasing their shares at a more affordable cost, as their market orders have less impact on the stock price.

While a stock split theoretically shouldn't affect the stock's market price, it often sparks renewed interest among investors. This renewed interest can positively influence the stock price, at least temporarily. Stock splits, especially by well-established companies, can signal a positive outlook to investors. It also indicates the company's confidence in future growth. A notable example is Walmart, which had 11 stock splits between 1970 and 1999, exponentially increasing early investors' shares.

Potential Downsides of Stock Splits

Despite their benefits, stock splits aren't without drawbacks. The process is costly and requires legal and regulatory compliance, leading to significant expenses for the company without changing its overall market capitalization.

Stock splits don't substantially change a company's value. The result is the same as slicing a cake. Further, stock splits might entice short-term investors rather than those with a long-term perspective.

By not splitting its Class A shares, Berkshire Hathaway has maintained an exclusive investor base and kept their price high. Companies that split their stocks to increase ownership don't use this strategy.

Additionally, reducing the share price too much can have regulatory implications. For example, the NASDAQ requires stocks to maintain a price above $1. Falling below this threshold can lead to compliance issues and, in severe cases, delisting from the exchange. This requirement adds a layer of complexity and risk to the decision to split stock.

How To Stay Informed Of Stock Split?

When keeping an eye on stock splits, it's important to note that they are typically announced several weeks before their effective date. To stay informed, you can utilize resources such as stock split calendars, with prominent examples like the one offered by Nasdaq. Additionally, many brokerage platforms provide their stock split calendars, which can be particularly handy. These tools inform you about upcoming splits and detail the split ratios and the dates when they are set to occur. However, it's worth noting that some of these resources may be exclusively available to individuals who hold accounts with the respective brokers.