Stock splits are corporate maneuvers that change a stock’s price without changing the company’s actual value or each investor’s stake. They are used primarily to make a stock more appealing to buyers. So, stock splits are a matter of perception.
The two main types of stock splits are standard stock splits and reverse stock splits. With the standard stock split, the number of shares increases, and the stock price decreases. A reverse stock split is when the shares decrease and the price increases.
There are also a few instances in which a company employs both reverse and standard stock splits in short order to reduce the number of shareholders.
It is important to emphasize that with any type of stock split, nothing changes regarding a company’s market cap or the value of a stockholder’s shares. Stockholders using portfolio management apps can record the stock split easily from the “stock split window”.
Why a Company Performs a Stock Split
Companies commonly use stock splits to make the price of a stock more appealing to investors. Standard stock splits generally make the cost of shares seem more like a bargain to attract more investors. Reverse splits make the share price seem more in line with what a company thinks the price should be or closer to the price of its competition.
These strategies are decided at the top levels of a company, usually the board of directors. They consider historical trading ranges, weigh regulatory costs, and factor in possible market reaction.
While the actual value of the company or the shareholder’s stake does not change, a standard stock split is usually a sign that a corporation is thriving. In contrast, a reverse stock split indicates a company is struggling.
Standard Stock Split
A standard, or forward stock split, is when a company decides to divide the number of shares and the price. Stock splits occur in ratios such as 2 for 1, 3-1, 4-1, and so forth.
For example, a company that performs a 2-1 split turns its 1 million outstanding shares into 2 million shares.
If the price was $200 a share before the split, it becomes $100 per share afterward. A shareholder that had 100 shares at $200 each, has 200 shares at $100 a share after the standard stock split. Nothing changes in terms of the company’s worth or the individual shareholder’s stake.
Apple, a company that has experienced tremendous growth over the past 30 years, has become famous for notable forward stock splits. In 2020, when Apple was going for $380 a share, the company issued a 4-1 split. That brought the share price to $95.
If you owned 20 shares of Apple before the split, you had 80 shares after the split. The strategy worked for the company and its investors; the price of Apple stock rose by 3% the day the split took effect, and it was trading for around $150 early by 2023.
Reverse Stock Split
A reverse stock split occurs when a company seeks to increase the stock’s per-share price and reduce the number of shares. Smaller companies sometimes do this to keep from being delisted on an exchange that requires a minimum listing price. Some investment funds also have minimum price rules. But a company may also order a reverse split to bring the price to a level they think will appeal more to a class of investors.
A reverse split, of course, is the reverse of a standard stock split. If a company has 1 million outstanding shares and performs a 1-4 reverse split, there will be 250,000 shares after the reverse split. If the price of a share was $10 before the 1-4 split, it becomes $40 after the reverse split. An investor’s 100 shares will be condensed to 25 shares.
During the global banking crisis in 2011, Citigroup executed a 1-10 reverse split to lift its price from around $1 a share back into double digits until the banking recovery. Citigroup has since bounced back, going for about $50 a share by 2023.
Reverse stock splits occur more during a down economy or when the overall market is retreating. Again, a reverse stock split does not change the value of the company or an individual investor’s stake. But a reverse split is often a sign of a struggling company.
Reverse/Forward Split
There are instances in which a company will employ a reverse stock split followed by a forward split. This sounds strange, but there are times when the company is willing to buy out stockholders who have fewer than a certain number of shares.
The reverse split reduces the number of shares a shareholder owns, making ineligible investors with a number fewer than the split allows. The company pays out the ineligible investors, then performs a forward stock split to return the stock price and the remaining investor shares to numbers similar to before the splits.
How a Company Performs a Split
Stock splits are the end result of considerable preparation. A company must first put its accountants and analysts to work predicting how the market and prospective buyers will react to various ratios, 2-1, 3-1, etc. Then their lawyers go to work on the legal aspects of the stock split. The company must clear the legal hurdles set by the Securities and Exchange Commission (SEC) before executing the split. The company must notify the SEC of the split at least 10 days ahead of its execution.
The company will then publicly announce the split, though news of the split often leaks and sometimes to the company’s advantage. The announcement comes with a record date and an ex-date. A person must have shares in the stock at close of business on the record date to be affected by the split. The actual split and the share and price adjustments come on the ex-date.
What a Stock Split Means for the Stockholder
The value of a stockholder’s stake in a company does not change with a stock split. A stock’s prospects may change because of the split; a forward split generally means positive things, while a reverse split often indicates a struggling company. In either case, a stock price may spike interest in the company around the time of the split and cause the share price to move. But the price usually settles after a few market sessions.
New Investors Like Stock Splits
Stock splits can generate market-wide excitement, particularly with large companies that perform forward splits. Since a forward stock split usually happens when a company is doing well, more people are likely to be interested both because of the company’s health and the reduced share price. Companies planning new growth often split stocks for extra revenue. There is evidence that companies outperform the broad market over the near term.
Wal-Mart famously executed 11 stock splits between its market debut in 1970 and 1999. An investor who bought 100 shares of the company at the beginning and held them saw those shares grow to 204,000 over the next 30 years.
Disadvantages of Stock Splits
Because stock splits involve extensive research and regulatory action, they can cost a company a lot of money. Companies may want to avoid a split if they think it won’t spike revenue enough to cover the costs and make the split worth the money. Larger or growing companies are more likely to be able to afford the extra costs of stock splits. Smaller, struggling companies may have to look closely at their budgets.
Stock splits often lead to share price volatility, which can work both ways. Not all stock splits increase the value of a stock in the long run. Remember, a stock split doesn’t change the company’s intrinsic value or an individual investor’s stake.
A reverse stock split often signals that a company is hanging on and acts as a red flag for shareholders and prospective shareholders.
Some companies also believe that stock splits draw the wrong kind of investors. They only want serious investors who are willing to hold shares over the long term. Berkshire Hathaway boss Warren Buffet classically never allowed a stock split for their Class A shares. These days, you can get in on BRK.A for around $460,000 a share.
Stock Splits: Perception and Speculation
Stock splits have a place in the market. They cause a lot of excitement and provide tools for companies’ growth or survival. But because stock splits don’t change a company’s fundamentals or a shareholder’s stake, then splits essentially add up to pure perception and speculation.
Companies that want to perform a split need to study closely to predict how the split will affect their overall health. In turn, shareholders and prospective buyers should look closely at why the company is using a stock split.
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