What Is A Stock Split And What Causes It?

Investing in stocks means you have to stay on top of how your investments are trending. When a company wants to appeal to more investors, they might issue a stock split. Here’s what a stock split is and how they matter to your investments.

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What is a stock split?

A stock split is when a company divides and increases the number of shares available to buy and sell on an exchange. A stock split lowers its stock price but doesn’t weaken its value to current shareholders. It increases the number of shares and might entice would-be buyers to make a purchase.

The total value of the stock shares remains unchanged because you still own the same value of shares, even if the number of shares increases.

How does a stock split work?

A stock split gets issued by a company’s board of directors in an effort to become more affordable to potential investors. The announcement tends to come a few weeks before the stock split goes into effect so current investors aren’t caught off guard and potential investors can make plans to buy shares.

The type of stock split can impact the total number of shares available. For instance, if a company issues a 2/1 stock split, the value of each share is cut in half. So if you own 50 shares of a stock that trades at $50 per share, you’ll now have 100 shares that trade at $25 a share.

Types of stock split

The type of stock split matters because it can tell you how a company is performing. A regular stock split might occur when a company believes the value of the stock is too high, which means a company is performing well and is looking to increase the number of shareholders in the company.

If you are unsure about how a stock split will affect your investments, it may be helpful to consult with a financial advisor to assist you with your individual financial goals and risk tolerance.

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Reverse stock split

A regular stock splits the existing number of shares into a bigger number of shares. A reverse stock split takes a large number of shares and reduces the number. For instance, in a 1-2 reverse stock split, a stock that was trading for $10 is now worth $20 a share and if you had 10 shares, you now have five.

A reverse stock split might be made to bring up the share price and in some cases, avoid being delisted as some exchanges have a minimum share price requirement.

2/1 stock split

This common stock split is when one share is divided in half. So if you have 50 shares of a stock valued at $50 each, a 2/1 split means you’ll have 100 shares valued at $25 each. This is one of the most common stock splits.

3/1 stock split

A 3/1 stock split is when a company splits a stock three ways rather than two. So if you have 100 shares of a stock valued at $30 each, you’ll have 300 shares valued at $10 each.

Examples of a stock split

Stock splits are not uncommon. In 2022, Alphabet — the parent company of Google — had a 20-for-1 stock split. This is one of the biggest splits in recent history.

Amazon also had a 20-for-1 stock split in 2022 and GameStop had a 4-for-1 stock split. Tesla had a 3-for-1 stock split last year as well.

Why do companies split their stocks

Companies might split their stocks when they believe the share price is too high for most people. By splitting stocks and cutting the price per share, they’re opening up the opportunity for more potential investors to buy into the company.

When a company does a reverse stock split, that might be a sign of trouble. This brings the stock price back up and means there are fewer available shares for people to buy.

Pros and cons of stock splits

Pros

• More buying opportunities. With the drop in stock price, a stock split can create more buying opportunities for potential investors. It’s more affordable to buyers who would otherwise not be able to afford it.
• Increase awareness. There might be more attention brought to a company that wasn’t there before the announcement of the stock splitting.

Cons

• Could become volatile. As some investors drop their shares and others start buying, stock splits can cause increased volatility. If you’re playing the long game, it’s important to remember that this is part of the risk involved in investing.
• Doesn’t increase value. Getting more shares doesn’t mean the value of those shares increase. But if you plan to stay in it for a while, the value could increase as more investors become shareholders.

How to watch out for stock splits

Stock splits are announced a few weeks before they go into effect. You can explore stock split calendars like this one from Nasdaq. Your broker might also offer a stock split calendar so you can see what the split ratio is and when they become payable. Sometimes these are only available to account holders.

Stock splits and fractional investing

Fractional investing is when you own a portion of one singular share of a stock. How you buy a fraction of a share depends on what’s offered. You might buy up to a certain dollar amount or you can buy up to a certain amount in fractional shares.

Stock splits and fractional investing are a couple of different ways to buy into a company that’s trading at a high dollar amount that’s more than you can afford. But not every company or brokerage offers fractional investing. While you might find this offered at some brokerages, it’s not universally available and at this point.

Should you take advantage of stock splits?

You might want to think about taking advantage of stock splits if you’re interested in buying into a stock and it’s been too expensive in the past. Stock splitting shouldn’t be the main reason you buy shares of a stock, but it might be a reason to look into investing in one.

Frequently asked questions (FAQs)

Does it matter to buy before or after a stock split?

If you buy a stock before it splits, you’ll pay more per share than what it’ll cost after it splits. If you’re looking to buy into a stock at a cheaper price, you may want to wait until after the stock split.

Who benefits from a stock split?

Companies who want to expand their shareholders and potential investors both benefit from a stock split.

Are stock splits risky?

All investments are risky, but some are more risky than others. If you’re looking to buy shares in a stock, you might be taking on more risk compared to other types of investments, like index and mutual funds.