What Is A Stock Split and What Causes It?
How they work, examples and (rumoured) upcoming company stock splits...
👋🏼 everyone,
I hope you're all having a good week so far.
There’s a lot of speculation at the minute that the AI giant Nvidia is planning to undertake a stock split, because the price per share is currently (at time of writing) a hefty $843 USD.
Now if you’re scratching your head about what a stock split is, why companies want to do them and most importantly why it matters to you, then please read on.
Today I’ll cover:
What is a stock split? 🧐
Why do stock splits happen and what it might mean for you? 🤑
A case study (using Apple) of a successful stock split
How to watch out for stock splits 👀
Stock split - 28 second 📹 explainer
What’s a reverse stock split? And why do investors hate them?
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(Quickly) explained…
In the simplest terms: when a (stock) split takes place, one expensive stock "splits" and becomes two or more cheaper stocks.
A stock split is where a company increases the size of their float (in the context of stocks, "float" refers to the total number of shares available for trading in the open market) by a predetermined ratio, without selling any more shares into the market.
This has the effect of lowering the price per share while also increasing liquidity i.e. the ease with which shares can be bought or sold in the market, (theoretically).
Let’s say a company has issued a float of 10 shares, each worth $200. The company decides to do a 5:1 stock split. This means that they now have a float of 50 shares, but each share is now only worth $40.
Person A owned 1 share at $200 before the split, for a total holding of $200. They now have 5 shares at $40, but still for a total holding of $200. Important: they did not have to buy these shares, they were automatically credited with them.
But hang on…will I lose out if the value of the share goes down?
No.
Existing shareholders are given additional shares automatically, so that the total amount invested does not change.
If you had a holding of AAPL (Apple) worth $10,000, you will still have a holding worth $10,000, you'll just have more shares, albeit each at lower values.
Why companies do a stock split?
Companies opt to split shares for various reasons, with psychology often playing a significant role. As stock prices rise, smaller investors may perceive them as too costly or unattainable. In theory, a split adjusts the price to a more appealing level, fostering a sense among current shareholders of increased ownership.
Splits facilitate the purchase of more shares. Investors often interpret this as a bargain, even though the stock's intrinsic value remains unchanged.
Traditionally, lower stock prices offer accessibility to investors with smaller portfolios, mitigating the risk of overexposure to a single stock. Today, the stigma surrounding "odd lots" of stock has diminished, making it more common to encounter investors with non-standard share quantities.
However, not all companies choose to split their shares. Warren Buffett has vocally opposed splits, exemplified by Berkshire Hathaway (BRK/A), whose shares trade around $463,000 each as of December 2022. Instead, Berkshire issued "B" shares to achieve similar accessibility. Similarly, Alphabet (GOOGL) refrained from splitting for almost eight years before executing a 20-for-1 split in July 2022, reducing the share price to $112.64 post-split.
Amazon (AMZN) underwent three splits between June 1998 and August 1999, followed by a 20-for-1 split in June 2022, dropping the price to $125 per share.
Reverse splits serve to potentially stabilize share volatility by increasing the price or discourage speculative trading by raising transaction costs. They may also be utilized to maintain the share price above a specific threshold, such as $1, to prevent delisting from the exchange.
Case Study of A Successful Stock Split 📝
(APPL) Apple's 7-for-1 stock split
This split allowed the price per share to decrease from over $600 to around $90. This made the stock more accessible to retail (everyday) investors and resulted in a surge in demand for the stock. Today, Apple's market capitalization is over $2.5 trillion.
How to watch out for stock splits 👀
Being aware of stock splits is important for investors.
Usually, companies announce these splits a few weeks ahead of time. You can stay in the loop by checking out stock split calendars, like this one on Nasdaq's website or Yahoo finance’s past and upcoming views of stock splits
Also, your brokerage might have its own calendar, so you can easily see the split ratio and when it'll happen.
📹 Stock Splits Explained…in 28 seconds
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What’s a reverse stock split?And, what do investors dislike them?
In summary, a reverse split is a corporate action that consolidates the number of shares outstanding.
What it means for an investor is that not much will change (aside from any price movement as a result of the reverse split).
During a reverse split your cost basis (i.e. the starting point of of your investment) will remain the same and you do not make or lose money (again aside from any price movement of the stock).
For example, if you own 100 shares at $1 per share you have $100 worth of stock. If the company executes a 10-1 reverse split then you will now have 10 shares at $10 per share, still worth $100.
Generally, a reverse stock split is not perceived positively by market participants.
It often indicates that the stock price has gone to the bottom and that company execs are attempting to inflate the prices artificially without any real business proposition.
Additionally, the liquidity of the stock also may take a toll with the number of shares getting reduced in the open market.
And that’s all for today’s post.
Thank you for reading as always 🙏 I hope this post has helped you feel more knowledgable about stock splits.
Before leaving, feel free to respond to this newsletter with questions or future topics of interest. And if you’ve found Concepts of Finance to be valuable, or just want to support the work I’m doing, consider subscribing and ❤️ liking this post.
Thanks and enjoy the rest of your week (and weekend!)
Jason
DISCLAIMER: None of this is financial advice. Concepts of Finance newsletter is strictly for educational purposes.
Well timed for NVDA!