What Happens When a Stock Splits? A Simple Explanation

A stock split is a corporate action to increase the number of its outstanding shares by dividing existing shares into multiple new shares, which adjusts the price per share. This action can influence how a stock is perceived and traded in the market.

The Mechanics of a Stock Split

When a company performs a stock split, it fundamentally changes the number of shares and their individual price. For instance, in a common 2-for-1 stock split, every share an investor owns is divided into two shares, proportionately reducing its price by half. If an investor held 100 shares of a company trading at $200 per share, their total investment would be $20,000. Following a 2-for-1 split, the investor would possess 200 shares, with each share now priced at $100. Similarly, a 3-for-1 split means each existing share becomes three shares, and the price per share becomes one-third of its original value. The goal is to adjust the share count and price while maintaining the overall market capitalization of the company.

Immediate Impact on Shareholder Value

Immediately after a stock split, a shareholder’s total investment value remains unchanged. While the number of shares an investor holds increases and the price per share decreases, their overall holding value is preserved. For example, if you own shares worth $5,000 before a split, you will still own shares worth $5,000 immediately after, just with a different share count and price. This is often compared to cutting a pizza into more slices; the total pizza remains the same, only the number of pieces changes. The split does not add or subtract value to the company or the investor’s portfolio.

Why Companies Implement Stock Splits

Companies implement stock splits for several strategic reasons. One primary motivation is to make shares more affordable and accessible to a wider range of investors. A high share price can deter smaller investors who find it intimidating or financially out of reach.

Lowering the per-share price attracts more individual investors, which can increase the stock’s liquidity and trading volume. Increased accessibility also improves marketability and broadens the investor base.

A stock split can also signal a company’s confidence in its future growth. It often occurs after a significant rise in share price, suggesting management believes positive performance will continue.

Understanding Reverse Stock Splits

A reverse stock split is the opposite of a standard stock split. Instead of increasing the number of shares, a reverse split consolidates existing shares into a smaller number of more valuable shares. For example, in a 1-for-10 reverse split, every ten shares an investor owns would be combined into one share, and the price per share would increase tenfold.

Companies undertake reverse stock splits to meet minimum share price requirements for listing on major stock exchanges. If a company’s stock price falls too low, it risks being delisted, which can negatively impact its credibility and trading visibility. A reverse split can also improve the stock’s perception in the market, as some institutional investors are restricted from investing in stocks below a certain price threshold.