What are Stock Splits?
All public traded companies have a set number of stocks ‘outstanding’ which means the number of stocks available to the market. A stock split is a decision made by a company’s board of directors to increase the number of shares by issuing more shares to the current shareholders.
For example, in a 2-for-1 stock split, an additional share is given for each share held by a shareholder. So, if a company had 10 million shares outstanding before the split, it will have 20 million shares outstanding after a 2-for-1 split.
Why do Companies Stock Split?
A stock split usually occurs when the stock price of a company increased to levels that are too high or beyond the price levels of their competitors. A price level is the average of current prices across the entire spectrum of goods and services produced in the sector.
Though splitting a stock will increase the stocks available in the market, the market capitalization remains unchanged. Market capitalization refers to the total dollar market value of a company’s outstanding shares of stock. This means the number of stocks x the price of the stock.
In June 2014, Apple Inc. split its shares 7-for-1 to make it more accessible to a larger number of investors. Right before the split, each share was trading at $645.57. After the split, the price per share at market open was $92.70, which is approximately 645.57 ÷ 7. Existing shareholders were also given six additional shares for each share owned, so an investor who owned 1,000 shares of AAPL pre-split would have 7,000 shares post-split. Apple’s outstanding shares increased from 861 million to 6 billion shares, however, the market cap remained largely unchanged at $556 billion.
As predicted, the day after the stock split, the price had increased to a high of $95.05 to reflect the increased demand from the lower stock price.
Why some Companies Avoid Stock Splitting?
Many companies prefer to avoid splitting because they believe a high stock price gives the company a level of prestige. A company trading at $1,000 per share, for example, will be perceived as more valuable even though the firm’s market capitalization may be the same as a company whose shares trade at $50.
Smaller companies may also wish to avoid stock splits because of a danger of share values falling too low. There have been cases where companies have split shares only to see the stock market dive, pushing shares below $10.
Stock Splits vs. Stock Dividends?
Stock split increase the number of shares by issuing more shares to the current shareholders whereas stock dividends are payments made by a company to the shareholders. To learn more about stock dividends: The Beginner’s Guide to Stock Dividends.
Are Splits Necessary Today?
Let’s imagine you’re looking to invest $5,000 today. You’re an Amazon prime member and an avid Amazon fan, and you decide to invest in Amazon. Unfortunately, Amazon’s stocks are currently trading at $1,800+ and that would account for 36% of your portfolio. This means you won’t be able to diversify your portfolio, leaving you with a high risk of losing a lot of money if Amazon stocks were to drop in price in the future.
In the past, this would be a limitation because it would be impossible to become a shareholder of a company unless you obtain enough money to buy at least a single share. But that’s no longer the case. There are a number of new platforms and services that allow investors to purchase fractional shares. Stockpile, M1 Investing, Betterment, Motif, and Stash are a handful of apps that have come on the market in recent years to allow investors to get started with small amounts of money.