How Stock Splits Work, and Why You Should Care About Them
10 Things to Know About Stock Splits
Alphabet (GOOGL) announced a 20-for-1 stock split on February 1, 2022.
And the next day everyone Googled, “what is a stock split?”
No, really. You can see the spike in searches in this Google Trends chart:
(source: Google Trends)
So, let’s break down all the nitty gritty details about stock splits and how they benefit traders!
What Is a Stock Split?
A stock split is when a company increases the amount of its shares without changing the company’s market value.
The most common type is a 2-for-1 forward stock split.
But a company’s board of directors can choose any ratio for a split, like Alphabet’s aforementioned 20-for-1 split.
How Does a Stock Split Work?
Let’s use a 2-for-1 split on a $100 stock.
Assume a company has 1,000 shares outstanding that are worth $100 each. That’s a market value of $100,000. (1,000 * $100)
The board of directors approves a 2-for-1 stock split.
So each $100 share would be split into 2 shares worth $50 each.
And the company’s total number of shares outstanding would increase from 1,000 to 2,000.
But the market value of the company remains the same:
1,000 shares x $100 = $100,000 market value
2,000 shares x $50 = $100,000 market value
Anyone who owned the stock before the split own the same dollar amount worth of stock, just divided into more shares. It’s like slicing a pie into 16 slices instead of 8.
If someone had 5 shares worth $100 each ahead of the stock split, they would then have 10 shares worth $50 each after the split.
What is the Point of a Stock Split?
You may be wondering why a company would do a stock split if there is no change in value.
Although a split itself does not make a company more or less valuable, it has the potential to push the stock higher.
Splitting a large stock makes it easier for smaller traders and investors to buy and increases the number of shares available to be purchased.
What Does a Stock Split Signal About a Company?
A stock split signals to the market that a company believes it will continue to grow and attract new investors.
By splitting the stock, the company makes it easier for more traders and investors to buy.
How Do Companies Typically Perform After a Split?
According to Zacks Investment Research, stock prices usually go up after a split.
The firm cites two studies which found split stocks outperformed the overall market by 8% the year after the split and 12% the following three years.
This could be partly caused by more investors buying the stock, because they feel like they are getting it for a lower price.
And more people buying the stock drives the value up over time.
Are There Other Kinds of Stock Splits?
There is another kind of split — a reverse stock split.
In a reverse split, the number of shares is reduced and the share price is increased.
Say a company has 1,000 shares worth $100 each, and implements a 1-for-2 reverse split.
Every two shares of the stock would be turned into one, leaving the company with 500 total shares worth $200 each.
The value of the company stays at $100,000.
But the number of shares shrinks and the individual share price is boosted.
Why Would a Company Do a Reverse Stock Split?
A reverse split is typically used to prevent delisting from an exchange.
The New York Stock Exchange, for example, has a minimum share price of $4 for a stock to be listed.
If a stock does not maintain that minimum, it can be delisted from the NYSE and sent to an over-the-counter (OTC) market.
Reverse splits are also used to boost a company’s image.
Many traders and investors look at single-digit stocks as risky investments.
So a company can use a reverse split to avoid that stigma.
Which Notable Companies Have Done Splits?
In the first week of February 2022 alone, there were 60 total splits.
Most of them didn’t get any attention.
But back in 2020, two of the biggest companies on Wall Street split their stock on the same day.
In August 2020, Tesla (TSLA) implemented a 5-for-1 split, while Apple (AAPL) did a 4-for-1 split.
Both companies began trading on a split-adjusted basis on Monday, August 31.
TSLA shares closed at $2,213.40 on Friday, August 28, making the 5-for-1 split equivalent to $442.68 per share.
Tesla’s stock hit new all-time highs of over $1,200 per share in November 2021, up more than 170% from the split.
AAPL has also seen success since its 4-for-1 split.
The iPhone maker’s stock closed at $499.23 on Friday, August 28, making the 4-for-1 split price $124.81 per share.
Apple became the first company in history with a $3 trillion market cap in January 2022 as shares rose to $182.94.
The tech giant said the goal of its split was to make the stock “more accessible to a broader base of investors.”
What Will GOOGL’s 20-for-1 Stock Split Look Like?
Up next for big stock splits is Google-parent Alphabet (GOOGL).
In its Q4 earnings report, the company announced a 20-for-1 stock split for Class A (GOOGL) and Class C (GOOG) shares.
The decision for such a big stock split comes as Alphabet shares are nearing $3,000 each.
To break down what this split will look like, let’s use that price.
Alphabet said the stock will begin trading on a split-adjusted basis on July 15, 2022, based on shareholders on July 1.
That means one must own the stock on or before July 1 in order to participate in the split. Those who buy shares after that date, will buy based on the split-adjusted price.
So if GOOGL shares are worth $3,000 each when the split is implemented, every one share will split into 20 that are worth $150 each.
That keeps the value the same for current shareholders, but makes the stock easier to buy for new traders and investors.
Obviously, $150 is easier to come up with to purchase a stock than $3,000.
Which Companies Have Never Done a Stock Split?
The most notable example of a company that has never split its stock is Berkshire Hathaway (BRK.A).
At writing, the stock is worth more than $481,000 per share.
Berkshire CEO Warren Buffett has never allowed the company to split its Class A stock, saying such a move would counter his philosophy of buy-and-hold investments.
Buffett wants investors in his company to be there for the long-term, not just buy and sell the stock.
Which Stocks Could Split Next?
With the announcement of Alphabet’s split, many are hoping Amazon (AMZN) is next.
The online retail giant’s shares are trading in similar territory as GOOGL, topping $3,000.
But Amazon’s Q4 earnings came and went with no split announcement.
Analysts still have the company at the top of their list for stocks primed to split next.
Comment below which stocks you’re eyeing for a split!