Stock splits explained in a split second!
July 13 2022 - Team Stockal
What is a stock split?
When a company is worried that its shares are trading too high and needs to boost its liquidity, it resorts to the corporate action called a stock split. A stock split makes it cheaper to buy and sell shares, thereby attracting new investors.
A company enacts a stock split by issuing more shares to its current shareholders while simultaneously reducing the price of each share by the same proportion. This ensures that the value of each shareholder’s stake and the company’s overall market capitalisation remain the same, despite an increase in the number of shares outstanding. Hence, a stock split is merely a cosmetic move that does not change the company’s fundamentals.
Exhibit 1: Stock split illustration
Graphic: Stockal Research
For example, imagine yourself holding one share worth $10 of a company. If the company decides to split its stock in the ratio of 2:1, it means you will receive two shares for every one share you hold. However, the value of each of the shares will be halved to $5 so that your two shares will still be worth $10 after the split.
What is the impact of a stock split?
While a stock split does not directly impact a company’s value, it sends some positive signals to the market. Firstly, a stock split creates new demand for a highly-priced share by making it more accessible to potential investors. This usually drives up the share price, albeit temporarily, following the split.
Secondly, it indicates management’s confidence in stock performance and conveys that a company’s share price has increased. The optimism trickles down to investors, who assume that this growth may also continue in the future.
What is a reverse stock split?
The opposite of a stock split is the reverse stock split, wherein a company reduces the number of shares outstanding by proportionately increasing the share price. For example, a 1-for-2 reverse stock split would give you one share for every two shares you hold while keeping the value of your stake unchanged. This is a less common corporate move which is usually undertaken to help the company remain listed on an exchange when its share price drops below the required minimum. Thus, a reverse stock split is usually taken as a red flag.
Reverse stock splits have also helped companies get back on track, like the online travel giant Priceline, now Booking Holdings (BKNG). Following the dot-com bubble burst, the company did a 1-for-6 reverse split in 2003. Since then, the stock has shown exponential growth to hit a record high of $2,703.26 in February this year. In fact, analysts are expecting this high-priced stock to split sometime soon to become more affordable for investors.
Notable stock splits
The world’s most valued tech company, Apple (AAPL), and chip designer Nvidia (NVDA) split their shares in a 4-for-1 ratio in August 2020 and July 2021, respectively. June 2022 also saw three notable companies going in for a stock split. The online retail giant Amazon (AMZN) enacted a 20:1 stock split on June 6. This was Amazon’s fourth split since its IPO in 1997 and the first since 1999.
Diabetes management technology company DexCom (DXCM) split shares in a 4-for-1 ratio, while Canadian e-commerce firm Shopify (SHOP) completed a 10-for-1 stock split in June. Meanwhile, Google-parent Alphabet (GOOGL) also announced a 20-for-1 stock split earlier this year in February. Its shares will start trading on a split-adjusted basis on 18 July 2022.
Exhibit 2: Timeline of Amazon stock splits
Amazon’s Stock splits in the past
Source: Stockal Research
Why wait for a stock split when you can invest in fractional shares!
Finding a share too expensive? There’s no need to wait for a stock split to happen! You can buy a portion of one full share of a company or an exchange traded fund (ETF) through fractional share investing. Also known as dollar-based investment, you need not bother about the number of shares to buy with this relatively new trading feature. You just decide the investment amount and get shares worth the dollar amount you invested.
Exhibit 3: Fractional share investing on Stockal
Fractional share investing offers common retail investors with limited funds a way to be shareholders of some of the fastest growing and highly valued companies and benefit from them. A share like that of Amazon might still be unaffordable for some investors after its recent stock split. Moreover, fractional share investing is the most apt for a company like Berkshire Hathaway, whose Class A stock (BRK.A) trades at over $400,000, and CEO Warren Buffett maintains a no-split stance on it. Via Stockal, you can invest as little as $1 and add the world’s most expensive stock in your portfolio.
A stock split, by itself, does not significantly impact the value of the current shareholder’s stake. The surge in share price post-split is usually temporary as the stock appeals to potential new investors at a reduced rate, driving the demand higher. However, one would need to hold the stock to reap benefits over time to make substantial gains.
Besides a human love for round numbers and our psychological bias towards owning one whole share instead of a fraction, stock splits do not have much relevance when fractional share investing is gaining popularity. Therefore, stock split or no stock split, fractional shares democratise equity investing and is the way ahead.