What is a Stocks Split?
In this article, we are going to explore a stock split. We are going to cover what a stock split is, why companies decide to do stock splits, the different types of stock splits, and how stock splits can impact investors.
If you are one of those people who read the last chapter in a book first…click here to skip to the Clear Creek Takeaways!
What is a stock split?
A stock split is a decision by a company’s board of directors to increase the number of shares that are outstanding by issuing more shares to current shareholders.
When a company goes public, it issues a certain number of shares, in what is called an Initial Public Offering or IPO for short.
As part of the IPO, the company decides how many shares they will issue to the public markets.
When Apple went public on December 12, 1980, they issued 4,600,000 shares. The price was $22.00 per share, not adjusting for their splits (we will learn about this later 😉).
Companies can do any number of splits. It could be 2-for-1, 100-for-1, 5-for-1, or anything in between.
If a company does a 5-for-1 split, it means that for every 1 share outstanding, there will now be 5. It will quintuple.
For example, let’s say Silver City Brewery decides to issue 1,000,000 shares of their company to investors for $10 per share. Their market capitalization would be $10,000,000 ($10 x 1,000,000).
Market Capitalization (Market Cap) is the current value of the company’s outstanding shares in the marketplace. To calculate it you simply multiply the current price for one share and multiply it by the current number of shares outstanding.
As years pass, Silver City Brewery continues to do well and those shares grow in value from $10 per share to $1,000 per share, their market cap is $1 billion ($1,000 x 1,000,000).
Silver City decides to do a 4-for-1 stock split, increasing the number of shares in Kitsap County from 1,000,000 to 4,000,000.
Their market cap will stay the same, at $1,000,000,000 but the share prices will fall from $1,000 to $250. (4,000,000 x $250 = $1,000,000,000).
But why do companies go through all the hassle of doing a stock split?
Why do stocks split?
There are 2 major reasons a company might decide to do a stock split.
- To lower the value of their stock
- To increase the liquidity of their stock
To lower the value of their stock:
If the value of a stock climbs too high, it can be hard for individual investors to afford the high price.
In the case of Apple, their stock reached a very high price of almost $500 per share in August of 2020, putting the stock out of reach of many investors.
By doing a stock split, Apple can divide existing shares into more shares driving the price of the stock down, allowing more potential buys access to the stock.
Let’s take a closer look at an example using Apple (AAPL), whose latest stock split occurred on August 31, 2020.
If you owned 1 share of Apple on Friday, August 25, 2020 it would have been worth just under $500. On Monday, August 31, 2020 your 1 share would have split into 4 (4-for-1), each share would be worth around $125 each ($499 / 4 = $125).
In one weekend, Apple lowered their stock price by 75% allowing more people the opportunity to invest it in.
Bonus Fact:
In general, most historical stock prices that you would see on Yahoo Finance or XXX, have been adjusted for stock splits. This is known as the split-adjusted price.
To Increase the liquidity of their stock:
The second reason for a stock split is to increase the liquidity of the stock.
According to Investopedia, “Increasing the liquidity of a stock makes trading in the stock easier for buyers and sellers. Liquidity provides a high degree of flexibility in which investors can buy and sell shares in the company without making too great an impact on the share price.”
When we are researching what ETFs and Stocks to purchase for our clients, one of the factors we look at is liquidity.
A lower level of liquidity generally means there is not a lot of buying or selling of that security.
If you want to buy 10,000 shares of a thinly traded stock (AKA low liquidity) there is the potential that there are not a lot of sellers. You may have to pay more for the shares than you like or you may not be able to buy as many shares as you wish.
How do Stock Splits impact investors?
We have already examined 2 ways a stock split can impact investors. It can lower the price of the stock and increase its liquidity.
There is also something else it can do which might seem obvious, it increases the number of shares an investor owns. This can be pretty dramatic over a long period of time.
Let’s take another look at Apple.
According to Apple’s website, they have split 5 times since their IPO on December 12, 1980.
| Apple | Splits |
| June 26, 1987 | 2-for-1 |
| June 21, 2000 | 2-for-1 |
| February 28, 2005 | 2-for-1 |
| June 9, 2014 | 7-for-1 |
| August 31, 2020 | 4-for-1 |
If you had bought 1 share of Apple stock in 1980, you would have 224 today!!
| Split | No. of Shares | |
| December 12, 1980 | 1 | |
| June 26, 1987 | 2 | 2 |
| June 21, 2000 | 2 | 4 |
| February 28, 2005 | 2 | 8 |
| June 9, 2014 | 7 | 56 |
| August 31, 2020 | 4 | 224 |
On August 25, 2020 Apple closed at $499.23 per share. If you had bought one share of Apple in 1980, that investment would have been worth almost $28,000 ($499.23 x 56 shares)!!
What is a Reverse Split?
If a company does a reverse stock split it decreases the number of outstanding shares in the market.
Let’s return to our Silver City Brewery example from above.
Let’s say Silver City Brewery has 1,000,000 shares outstanding and the price is $5 a share. If Silver City did a reverse stock split giving every investor 1 share for every 2. Outstanding shares would go from 1,000,000 to 500,000. The price would jump from $5 to $10.
A reverse stock split can help to make a stock more attractive to investors who may perceive it as more valuable with a “higher” stock price.
It can also help a public company avoid being delisted due to not meeting minimum price requirements for that exchange. For the Nasdaq, if a stock trades lower than $1 for 30 consecutive days, it will be delisted.
A reverse split can also signal that a company is in trouble.
Clear Creek Financial Takeaways
A stock split is a decision by a company’s board of directors to increase the number of shares that are outstanding by issuing more shares to current shareholders.
It can impact investors by:
Affecting the price:
A traditional forward split can lower the stock price, making the stock seem affordable to the average investor. A reverse split can increase the stock price, making it more attractive to investors who perceive it as more valuable with the higher stock price.
Affecting the liquidity:
A stock split will increase the liquidity of a stock by creating more shares within the market place facilitating easier trading for both buyers and sellers. A reverse stock split will lower the liquidity of a stock, making the stock more cumbersome to trade.
Affecting an Investors Shares:
Over a long period of time, stock splits can significantly increase the number of shares an investor owns. As we mentioned above, an investor that bought 1 share of Apple in 1980 would have 256 shares as of August 31, 2020.
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