What Is a Stock Split and How Do They Work?

What is a stock split?

Investors consider several factors before investing in stocks. A stock share price can be one of the most important criteria as investors may be hesitant to invest most of their portfolio into a single expensive stock.

Companies sometimes perform a stock split to make stock shares more affordable for retail investors and allow more people to invest in the company.

Here’s an in-depth look at how stock splits work for any investor.

What is a Stock Split?

A stock split is when a publicly traded company or exchange-traded fund increases the number of stock shares available on the stock market.

For example, doubling the number of shares from 1 million to 2 million can reduce the share price from $100 to $50 per share. The company has the same market capitalization (share price x total number of stock shares) but the stock price is lower.

This practice is sometimes called a “forward stock split.” It’s more common than the other type of stock split.

It’s also possible for companies to reduce the number of outstanding shares and increase the share price with a “reverse stock split.”

Do Stock Splits Change Company Valuation?

Not exactly. A company’s market valuation is determined by multiplying the total number of shares by the current share price.

A stock split adjusts the share price and total number of shares but has the same valuation.

Investors, analysts and market pundits may consider stock splits a type of “accounting trick.” A stock split can mentally motivate hesitant investors to start investing in the company because of the lower price.

For example, it’s easier to afford a $100 share versus a $500 share while maintaining a diversified portfolio.

Stock Split Examples

There are several different ways a company can perform a stock split. Here are some examples.

2-to-1 Stock Split

A 2-to-1 split doubles the number of outstanding shares while halving the current share price.

2-to-1 Stock Split
  Before Split After Split
Share Price $100 $50
Total Stock Shares 1 million 2 million

3-to-1 Stock Split

A 3-to-1 split triples the number of shares while reducing the share price to a third of the current price.

3-to-1 Stock Split
  Before Split After Split
Share Price $100 $33
Total Stock Shares 1 million 3 million

4-to-1 Stock Split

A 4-to-1 split quadruples the number of shares and the new share price is 25% of the current price.

4-to-1 Stock Split
  Before Split After Split
Share Price $100 $25
Total Stock Shares 1 million 4 million

Reverse Stock Split

The previous examples are for forward stock splits. In some instances, companies may do a reverse stock split, reducing shares and increasing the share price.

Below is an example of a 2-to-1 reverse stock split. You will see the share price double while the total number of shares shrink by 50%.

2-to-1 Reverse Stock Split
  Before Split After Split
Share Price $50 $100
Total Stock Shares 2 million 1 million

Reverse stock splits are less common than forward stock splits. Usually, companies do reverse splits to avoid being classified as a “penny stock” and being delisted from a stock exchange or widely-tracked index (like the S&P 500 or Russell 2000).

For example, a company may initiate a reverse split to keep the shares above $5 to remain in index funds. If a stock is delisted from a fund or specific stock market, its share price and company valuation fall further.

All reverse stock splits are not bad, but they usually signal financial trouble for a company.

One recent example is General Electric (Ticker: GE) in March 2021 proposing a 1 to 8 reverse split. This move would multiply the share price by 8 ($15 to $120) and the post-split number of shares is one-eighth of the current amount.

Notable Stock Splits

Here are some high-profile stock splits to see well-known companies increasing their shares available to reduce the per-share price.

Tesla

Tesla announced a 5-to-1 stock split in August 2020. Shareholders as of August 28, 2020, saw their total shareholding multiple by five and the price began trading at the split-adjusted price on August 31, 2020.

Apple

The most recent Apple stock split was in August 2020. Shareholders got a 4-for-1 split meaning their total number of shares multiplied by four on August 24, 2020. This pre-split share price was approximately $400 per share and was reduced to $100 post-split.

The company has done four other stock splits in these years:

  • 2014 (7-for-1)
  • 2005 (2-for-1)
  • 2000 (2-for-1)
  • 1987 (2-for-1)

Stock Split Calendar

Stock splits happen regularly for individual companies and exchange-traded funds. Traditional online brokerages like Fidelity or Vanguard may offer a stock split calendar.

Another option is to visit the stock market exchange website. The Nasdaq stock exchange lists upcoming splits.

Third-party platforms like Yahoo! Finance also provide a comprehensive look at no extra cost. 

What Should Investors Do During a Stock Split?

The answer may depend on whether you’re an existing shareholder or a potential investor.

Existing Shareholder

Stock splits can be confusing to investors that currently hold shares of stock. After all, you only expect the number of shares you own to change when you buy or sell stock or re-invest dividends.

In most instances, the best answer is to do nothing when a company announces a stock split. While your total shares position and per-share price change, your unrealized investment performance doesn’t change.

You may decide to buy more shares after the split because the stock is cheaper to purchase but the company has the same financial fundamentals.

However, you may decide to sell if the stock price becomes more volatile. Cheaper shares means that more short-term traders might invest and sell once the technical indicators change to make a quick profit.

Potential Investors

Investors looking to start a position should consider their long-term and short-term investment goals.

Long-Term Investors

Stock splits don’t affect long-term investors as much as before. One reason why is because of fractional investing. Many brokers now let investors buy partial shares of stock with a minimum investment of $5. Some platforms only have a $1 investment minimum.

A forward stock split makes it easier to buy a whole share which can be a mental victory. For investors that must buy whole shares, a lower stock price can still be essential to directly invest in a company instead of through a stock fund.

Short-Term Traders

Short-term traders may capitalize on stock splits for technical analysis-based trades. They may buy shares, hope for positive momentum and sell when the stock triggers a selling condition.

Two examples can be dipping below the 200-day moving average or an “overbought” relative strength indicator (RSI). Each short-term trading strategy is different.

Is a Stock Split Good or Bad?

In most cases, a stock split can have positive outcomes for investors and the company. Here’s a quick look at the pros and cons of stock splits.

Stock Split Advantages

These are the potential positives of a stock split.

Cheaper Share Price

A lower share price means more investors can buy whole shares. While many online brokers offer dollar-based fractional investing, purchasing one share versus a tiny slice can bring mental satisfaction.

For investors that can only buy whole shares, a stock split means they can finally open a tiny position.

Can Increase Share Volume

More interest in a stock can increase share volume. If more investors buy shares, the share price can increase. Rising share prices cause the company’s market valuation to rise.

Current Investors Get More Shares

Long-term investors can benefit from the increase in total shares they own. When it comes time to rebalance their portfolio or sell investments to pay for retirement, forward stock splits mean they may not have to sell the entire share balance at once.

Optimistic Market Headlines

A stock split announcement can bring media coverage and other news headlines a company wouldn’t receive.

Suppose the stock split gets positive coverage instead of being labeled as a publicity stunt to distract the market from financial troubles or corporate scandals. In that case, investors may have an optimistic perception of the company.

The announcement can also reach investors that might be unfamiliar with the company but may become a new investor.

Stock Split Disadvantages

Here are several potential negatives of a stock split.

Potential Share Price Volatility

A cheaper share price means more people can invest which can naturally lead to more trading volume. However, if most of those investors only have a short-term investment horizon, the share price can fluctuate more than before the split.

These gyrations may be temporary but they can still test the patience and nerves of buy and hold investors.

Low Share Price

Companies must carefully calculate the magnitude of a stock split to ensure the share price doesn’t go too low. For example, they may only do a 2-or-1 split instead of a 4-for-1 split to avoid making the shares “too cheap.”

Most shares need to remain above $5 to be listed in the major stock indexes so stock funds can invest in them. An aggressive stock split plus an unforeseen market selloff may cause the share price to go too low and punish investors as a result.

Record-Keeping Challenges

Investing software is more intelligent than before and can more accurately track long-term investment performance. Having an accurate investment cost basis is vital to make sure you calculate the correct profit (or loss) and pay the appropriate capital gains taxes.

A tracking error can erase years of gains if it’s not discovered.

Splits can also impact stock screeners and researching historical data. Most research tools and price charts annotate splits and dividend payments but these events can skew the numbers.

Summary

Overall, a stock split makes shares more affordable for new investors wanting to open a position and existing shareholders can buy more shares. The stock’s market valuation doesn’t change but a stock split can shift investor sentiment.