What is a Stock Split?

Introduction

Stock splits may seem confusing at first, but they’re a common and strategic move made by publicly traded companies. This guide from TradeSmart explains what stock splits are, how they work, and the reasons companies choose to split their stock.

We’ll also explore the potential implications for investors and how understanding stock splits can help you refine your investment strategy and make informed decisions in the stock market.

What is a Stock Split?

A stock split is a corporate action where a company increases the number of its outstanding shares by issuing more shares to current shareholders. This is done by dividing each existing share into multiple shares. For example, in a 2-for-1 stock split, each existing share is replaced with two new shares.

How Does a Stock Split Affect Investors?

More Shares: After a stock split, you’ll own more shares of the company.
Lower Price per Share: The price per share will decrease proportionally to the split ratio. For example, in a 2-for-1 split, the price per share will be halved.
Same Overall Value: The total value of your investment remains the same immediately after the split. You simply own more shares at a lower price per share.

Example:

Imagine a company’s stock is trading at $100 per share. They decide to do a 2-for-1 stock split. After the split:

You’ll have twice as many shares as you did before.
The price per share will be $50.
The total value of your investment will remain unchanged.

Impact on the Market

Stock splits can sometimes generate increased interest in a stock and lead to higher trading volume. This is because the lower share price makes the stock more accessible to a wider range of investors.

TradeSmart provides traders with the tools and resources they need to understand and analyze stock splits. Our advanced trading platforms, educational materials, and market insights empower investors to make informed decisions and navigate the complexities of the stock market.

How Stock Splits Work

Understanding how stock splits function is crucial for investors exploring the market. A stock split occurs when a company divides its existing shares into multiple shares, increasing the total number of shares while adjusting their price proportionally. This corporate action maintains the overall market capitalization.

Forward Stock Splits

You’ll often encounter forward stock splits, which increase the total share count. In a 2-for-1 stock split, for example, one existing share divides into two. Thus, an investor with one share now possesses two shares, effectively doubling the number of outstanding shares.

The adjustment in share price follows a straightforward calculation. When a company executes a 2-for-1 split, the price per share is reduced by half. A share priced at $100 before the split then becomes $50 afterward. The company’s market capitalization remains unchanged at $100, as the increased share count offsets the lower price per share.

Forward stock splits typically improve liquidity and accessibility. Lower prices attract a broader range of investors, fostering more trading activity as stocks become within reach for casual investors.

How a Stock Split Works

Company Announcement: The company announces the stock split, specifying the split ratio (e.g., 2-for-1, 3-for-1).
Record Date: A record date is set. Shareholders on record as of this date will receive the additional shares.
Split Execution: On the effective date, the split is executed, and the number of shares is increased, while the price per share is reduced accordingly.

Example:

Imagine a company’s stock is trading at $100 per share. They decide to do a 2-for-1 stock split. After the split:

You’ll have twice as many shares as you did before.
The price per share will be $50.
The total value of your investment will remain unchanged.

Why Do Companies Split Their Stocks?

Companies split their stocks for various strategic reasons aimed at enhancing market performance and investor engagement.

Stock splits are a common occurrence in the stock market, and companies undertake them for several strategic reasons:

Increased Accessibility: When a company’s stock price becomes very high, it can be difficult for smaller investors to afford to buy shares. A stock split lowers the price per share, making it more accessible to a wider range of investors.
Improved Liquidity: A stock split can increase the liquidity of a stock, meaning it’s easier to buy and sell shares without causing large price swings. This can benefit all investors, as it makes it easier to enter and exit positions.
Positive Signaling: A stock split can be seen as a positive signal by the company. It often suggests that the company is confident in its future growth prospects and that its stock is undervalued.
Index Inclusion: Some stock market indices have requirements for the price of stocks that can be included. A stock split can help a company meet these requirements and gain inclusion in a major index, which can increase visibility and investor interest.

Forward Stock Splits

A forward stock split is a corporate action where a company increases the number of its outstanding shares. This is done by dividing each existing share into multiple shares. For example, in a 2-for-1 stock split, each existing share is replaced with two new shares.

Why Companies Do Forward Stock Splits

Increase Affordability: When a company’s stock price gets very high, it can be expensive for many investors to buy even a single share. A stock split lowers the price per share, making it more accessible to a wider range of investors.
Improve Liquidity: A lower share price can increase trading volume and liquidity, making it easier for investors to buy and sell shares.
Signal Confidence: A stock split can be seen as a positive signal by the company. It often suggests that the company is confident in its future growth prospects.

How a Forward Stock Split Works

Company Announcement: The company announces the stock split and the split ratio (e.g., 2-for-1, 3-for-1).
Record Date: A record date is set. Shareholders on record as of this date will receive the additional shares.
Split Execution: On the effective date, the split is executed, and the number of shares is increased, while the price per share is reduced proportionally.

Imagine a company’s stock is trading at $100 per share. They decide to do a 2-for-1 stock split. After the split:

You’ll have twice as many shares as you did before.
The price per share will be $50.
The total value of your investment will remain unchanged.

Forward stock splits serve various strategic purposes. They can attract a broader range of investors by making shares more affordable. As share prices drop, retail traders who may have been deterred by high prices may now find it easier to invest. Increased trading activity often accompanies this enhanced accessibility.

Historically, many successful companies, particularly within the technology sector, have utilized forward stock splits to manage high share prices. Major firms like Apple and Google have undertaken such splits to improve their share structure while signaling confidence in their growth potential. Market sentiment shifts positively following these splits, as they often lead to heightened trading volumes and investor interest.

Visual representations of forward stock splits, such as graphs illustrating price changes and increased share count, can aid in comprehension. You might see a chart showing the original share price compared to the adjusted price post-split, displaying how the market capitalization remains consistent.

The decision to initiate a forward stock split reflects management’s expectations of future growth. By breaking down share prices into more manageable levels, companies position themselves favorably within market indices, ensuring they remain competitive and attractive to both institutional and retail investors.

Conclusion

Stock splits are a regular feature of the stock market, and while they don’t change a company’s underlying value, they can influence share price, market accessibility, and investor sentiment.

At TradeSmart, we provide the tools and knowledge you need to confidently navigate stock splits and other corporate actions. From real-time data on our advanced platforms like MetaTrader 4 and MetaTrader 5 to comprehensive educational resources, you’ll have everything you need to: