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.
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How Do Stock Splits Work?
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.
Very clear as to the share quantity increasing while the total Value remaining the same. Now how is a dividend factored into to the equation?
Hi, Bud,
If there is a 2-for-1 stock split, the dividend would also be cut in half, just as the share price is cut in half.
BB