What is a Stock Split?
A Stock Split occurs when a publicly-traded company’s board of directors decides to separate each outstanding share into multiple shares.
Table of Contents
How Stock Splits Work (Step-by-Step)
The rationale behind stock splits is that individual shares are currently priced so high that potential shareholders are deterred from investing.
Stock splits are most often declared by companies with share prices determined as being too high, i.e. the shares are no longer accessible to individual investors.
Stock splits cause a company’s share price to become more affordable to retail investors, thereby broadening the investor base that could own equity.
More specifically, an abnormally high share price can prevent retail investors from diversifying their portfolios.
By allocating a greater percentage of their capital towards shares in one company, an individual investor takes on more risk, which is why the average everyday investor is unlikely to purchase even one high-priced share.
For instance, the share price of Alphabet (NASDAQ: GOOGL) as of the latest closing date (3/2/2022) was roughly $2,695 per share.
If an individual investor has $10k in capital to invest and purchased a single Class A share of Alphabet, the portfolio is already 26.8% concentrated in one share, meaning that the portfolio’s performance is largely dictated by Alphabet’s performance.
After a stock split, the number of shares in circulation increases, and the share price of each individual share declines.
However, the market value of the company’s equity and the value attributable to each existing shareholder remains unchanged.
The effects of a stock split are summarized below:
- Number of Shares Increases
- Reduction in Market Value Per Share
- More Accessible Stock to Broader Range of Investors
- Increased Liquidity
Stock splits theoretically have a neutral impact on a company’s overall valuation, despite the decline in share price, i.e. the market capitalization (or equity value) remains unchanged post-split.
But there are certain side considerations such as the increased liquidity within the markets that could benefit existing shareholders.
Once a stock split has occurred, the range of investors that can potentially purchase stocks in the company and become shareholders expands, resulting in greater liquidity (i.e. easier for existing shareholders to sell their stakes in the open markets).
Unlike issuances of new shares, stock splits are not dilutive to existing ownership interests.
A stock split can be visualized as cutting a slice of pie into more pieces.
- The total size of the pie does NOT change (i.e. equity value remains unchanged)
- The slice belonging to each person does NOT change (i.e. fixed equity ownership %).
However, the one detail that does, in fact, change is that more pieces can be distributed to people who may not have a slice.
Companies that have historically performed stock splits have been shown to outperform the market, but stock splits result from growth and positive investor sentiment rather than the stock split itself being the cause.
Stock Split Ratio and Split-Adjusted Price Formula
|Stock Split Ratio||Post-Split Shares Owned||Split Adjusted Share Price|
Let’s assume that you currently own 100 shares in a company with a share price of $100.
If the company declares a two-for-one stock split, you would now own 200 shares at $50 per share post-split.
- Shares Owned Post-Split = 100 Shares × 2 = 200 Shares
- Share Price Post-Split = $100 Share Price ÷ 2 = $50.00
Dividends and Stock Splits
If the company undergoing a stock split has a dividend, the dividends per share (DPS) issued to shareholders will be adjusted in proportion to the split.
Stock Split Calculator – Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Stock Split Calculation Example
Suppose a company’s shares are currently trading at $150 per share, and you’re an existing shareholder with 100 shares.
If we multiply the share price by the shares owned, we arrive at $15,000 as the total value of your shares.
- Total Value of Shares = $150.00 Share Price × 100 Shares Owned = $15,000
Let’s say the company’s board decides to approve a 3-for-1 split. You now hold 300 shares, each priced at $50 each post-split.
- Total Shares Owned = 100 × 3 = 300
- Share Price = $150.00 ÷ 3 = $50.00
After the split, your holdings are still worth $15,000, as shown by the calculation below.
- Total Value of Shares = $50.00 Share Price × 300 Shares Owned = $15,000
Given the reduced share price, you are more likely to sell your shares more easily because there are more potential buyers in the market.
Google Stock Split Example (2022)
Alphabet Inc. (NASDAQ: GOOG), the parent company of Google, stated in early February 2022 that a 20-for-1 stock split would be enacted on all three classes of their shares.
Alphabet Q4-21 Earnings Call
“The reason for the split is it makes our shares more accessible. We thought it made sense to do.”
– Ruth Porat, Alphabet CFO
As of July 1, 2022, each Alphabet shareholder will be given 19 more shares for each share already owned, which will be transferred on July 15 — shortly afterward, its shares begin trading at the split-adjusted price on the 18th.
Alphabet Q-4 2021 Results — Stock Split Commentary (Source: Q4-21 Press Release)
Alphabet has a three-class share structure:
- Class A: Common Shares with Voting Rights (GOOGL)
- Class B: Shares Reserved for Google Insiders (e.g. Founders, Early Investors)
- Class C: Common Shares without Voting Rights (GOOG)
Hypothetically, if the split for GOOGL were to occur in March, as of its latest closing price of $2,695, each share post-split would be priced at approximately $135 apiece.
Since Alphabet’s announcement, many investors have urged other companies with high share prices to do the same, and many are expected to follow their lead, such as Amazon and Tesla.
Alphabet’s stock split should not have a material impact on the share of its valuation — yet, considering how long-awaited the stock split was and how its shares were trading near $3,000 per share — the influx of new investors and more volume could still affect its market value.