What Are Stock Splits? Guide to Understanding the Basics

A stock split is a mechanism that some companies, usually with stock prices that are high, use to increase (or reduce depending on the split) the number of existing shares. This also will increase or reduce the value of each share.

Here’s the important facts about stock splits you should know as a stock trader/investor.

What is a Stock Split?

A stock split is a corporate action in which a company divides its existing shares into multiple shares/fewer shares to boost the liquidity.  When companies do a stock split, they are offering investors/traders more possibilities to purchase or trade shares at reduced costs compared to before.

Splitting the existing shares of a company into multiple new ones increases the total number of outstanding shares. A stock split also reduces each share’s price point to make it more affordable for retail traders and investors.

Reasons for Stock Splits

Stock splits are a common occurrence in the stock market. A company’s board of directors has the power to split its shares. When shares are split, each is broken down into smaller parts. The total number of shares increases, but the price of each individual share goes down.

One reason companies may choose to do a stock split is to make their shares more attractive and affordable for potential buyers.  Split stocks can make it easier for the average investor to purchase shares, as well as boost a corporation’s stock trading activity.

When Apple Inc. did a 7-for-1 stock split in June of 2014, it reduced its share price from $645 per share down to around $92.69 per share after the split was completed. By making its shares more accessible, Apple hoped that more people would invest in them since they were now much cheaper than before the split took place.

An increase in trading activity can be great for existing shareholders, as it increases liquidity and may push up prices due to increased demand from the wider market. With heightened visibility resulting from this increase in activity, institutional investors who previously may have been put off by high prices or low liquidity levels associated with certain stocks prior to their split, could now be enticed to invest.

Management teams and boards may opt for a “stock buyback” as part of their strategic financial planning, allowing existing shareholders to sell back some (or all) of their holdings at predetermined prices within certain time frames.

This gives them the opportunity to raise funds without having to issue new equity or selling additional assets outright, while avoiding dilution concerns and other risk factors associated with issuing new securities.

The primary benefit of stock splitting is that it renders investing accessible and affordable, even for those with limited funds.

Types of Stock Splits

There are two main types of stock splits: forward and reverse.

A forward split is when a company divides its existing shares into more, while reducing the price per share to maintain market capitalization. For example, if a company has 1 million shares at $10 each, they could do a 2-for-1 forward split that would result in 2 million shares priced at $5 each. The total value remains unchanged since the number of shares doubled but the price per share was cut in half.

This type of split makes stocks more affordable for smaller investors and can signal confidence from management about future growth prospects.

Reverse stock splits occur when shares are converted into fractional shares.  An example would be a 1 for 5 reverse split where for every 5 shares you own, they are converted into 1 share.  A reverse split implies that there is not sufficient demand for existing shares and so fewer are created.

Stock splits are a powerful tool for companies to manage their stock price and liquidity. So, let’s delve further into the advantages of stock splits.

Benefits And Risks of Stock Splits

It’s important for investors/traders to understand both the benefits and risks associated with stock splits.

Investors should weigh the potential benefits against the risks associated with stock splits before making any investment decisions.

Stock Splits FAQs

What is the explanation of stock splits?

Stock splits occur when a company decides to divide its company’s stock into multiple new shares. This is usually done in order to make the stock more affordable and accessible for investors, as well as increase liquidity.

The price of each share is reduced proportionally while the total market capitalization remains unchanged. An example of a stock split is if an investors owns one million shares, each at $100, opts for a 2-for-1 division; it will then have two million shares priced at fifty bucks apiece.

What are major reasons for stock splits?

Stock splits are a common corporate action that can benefit both shareholders and the company. A firm may choose to split its stocks, resulting in the creation of multiple new shares and a higher total number of outstanding ones with lower individual costs. Split stocks tend to be more accessible to the average trader can be more volatile, can increase liquidity, and bolster investor confidence in the long-term prospects of a company.

Conclusion

Stock splits can be a beneficial tool for both everyday investors and experienced traders. It is important to understand the reasons why companies decide to split their stocks, as well as the different types of stock splits available in order to make informed decisions about investing in them.

Though there are some potential dangers, those who comprehend the process and do their homework can reap rewards by exploiting these chances when they present themselves. With proper research and understanding of this process, traders can maximize their returns by taking advantage of these opportunities when they arise.