Earlier this year, several prominent companies announced stock splits this year, including Nvidia (NVDA), Chipotle Mexican Grill (CMG), Broadcom (AVGO), and MicroStrategy (MSTR). Cloud company Arista Networks (ANET) just announced its own earlier this month.
As 2025 looms, there are a bunch of candidates out there to speculate on that could be next, with heavy hitters Microsoft (MSFT) and ASML Holding (ASML) on the radar. But until then, lets revisit stock splits and their impact on Wall Street.
What Is a Stock Split?
If you’re new to the stock market, you may have heard about stock splits and are wondering what they are. A stock split is simply a corporate action in which a company divides its existing shares into multiple shares. They can also be more complex, like a reverse stock split. But for now, let’s discuss what a traditional stock split is in more detail.
Stock splits can be 2-for-1, meaning each shareholder gets two new shares for everyone’s old share. For example, if a company has 1,000 shares of stock and it performs a 2-for-1 split, then the company will have 2,000 shares of stock.
The shares will be worth half as much as they were before the split, but there will be twice as many shares. So if each share was worth $100 before the split, then each share will be worth $50 after the split.
However, the value of the company will remain the same. This is because a stock split does not add any new value to the company, it simply divides the existing shares into multiple shares. It also does not take away any value from the company. It is simply a way to divide the shares among more shareholders.
Stock splits can also be for other denominations such as four-for-one or eight-for-one etc. These larger splits can be helpful for expensive stocks such as Shopify. At its peak, it reached close to $2000.
A four-for-one split would have made it more affordable for many investors ($500 per share) who may have been interested in the company. If they didn’t want to spend that much money on a single share, they could have bought one share for 75% of what the original cost would have been.
Now that we know what a stock split is, let’s briefly discuss what a reverse stock split is and how it works.
What Is a Reverse Stock Split?
A reverse stock split is when a company’s board of directors decides to decrease the number of outstanding shares. For example, if a company has 100 million shares outstanding and does a two-for-one reverse stock split, then the company would have 50 million shares outstanding after the split.
Shareholders would own half as many shares, but each share would be worth twice as much. So if each share was worth $100 before the split, then each share would be worth $200 after the split. Like a traditional stock split, a reverse stock split does not add or take away any value from the company. It’s just a method to decrease the number of outstanding shares.
The reason why a company would do a reverse stock split is to increase the price per share. Some exchanges have rules about the minimum price per share that a company can have to be listed on the exchange. By doing a reverse stock split, a company can increase its stock price so that it meets the listing requirements.
Why Do Companies Perform Stock Splits?
There are a few reasons why companies might choose to perform stock splits.
One reason is that it can make the shares more affordable for small investors. For example, if a company’s shares are trading at $200 each, it may be too expensive for some people to buy just one share. But if the company does a two-for-one split, then the price of each share will drop to $100 and more people will be able to afford to buy the shares.
Another reason companies perform stock splits is to increase the liquidity of their shares. This means that it will be easier for people to buy and sell the shares. A lack of liquidity in the stock can make it difficult to find buyers or sellers, which can lead to a lack of interest in the stock.
Stock splits can also make a company’s shares look more attractive to investors. This is because when a company’s shares are trading at a high price, it can look like the company is overvalued. But if the company does a stock split and the share price drops, then it can look like a bargain.
How Do Stock Splits Affect Shareholders?
Stock splits can have different effects on shareholders depending on the reason why the company is doing the split.
If a company is doing a stock split to make its shares more affordable, then it will likely have a positive effect on shareholders. This is because more people will be able to buy the shares, which will increase demand and drive up the price.
When it comes to increasing liquidity, stock splits will also be positive for shareholders. They may be able to get a better price for their shares, which leads to more trading volume and higher profits.
In general, stock splits tend to be positive for shareholders since they usually result in higher demand for the shares and a higher share price. But it’s important to remember that each situation is different and you should always do your own research before investing in any company.
Should I Buy a Stock Split?
If you see that company’s high-priced stock you’ve had on your watch list announce a stock split, you might ask yourself, “Should I buy a stock split?”
As we’ve discussed, stock splits can have a positive effect on shareholders, but that doesn’t mean you should automatically buy the shares just because there’s a split.
You should always do your own research before investing in any company. This includes looking at the financials, the management team, the competitive landscape, and any other factors that might affect the company’s performance.
A stock split is simply a corporate action and it doesn’t necessarily mean that the company is doing well or that its shares are a good investment. So make sure you do your due diligence before buying any shares. Some companies might even trap unwary investors by doing a stock split just before announcing bad news.
Why Do Stocks Split?
Stock splits can be a confusing topic, but we hope this article has helped to clear some things up. Don’t let the change of price fool you into believing that your investment has lost value.
A stock split simply indicates that a company’s share price has become too expensive for some investors, so the company splits the shares to make them more affordable. It changes nothing about the underlying value of the company.
In most cases, stock splits are positive for shareholders since they result in higher demand for the shares and a higher share price. But fundamental analysis is still the key to finding good investments. Don’t forget to do your own research before investing in any company, even if it’s doing a stock split.