Same Pie, More Slices: Splitting Stock
Stock splits begin with a company announcement that it intends to divide up each share of its stock into a set amount of units. Let’s say a company’s board of directors decides to cut the share price in half and double the number of shares outstanding. For each share you owned before the split, you’d receive two, proportionally less expensive shares after (this would be a 2-for-1 split).
A stock split makes a company’s shares more affordable, keeping the company’s overall value the same while dividing its existing shares into a greater number of smaller, less expensive shares.
The company will set a day on which the split takes effect. At the close of business, all investors holding stock will have the number of shares held converted along the terms of the stock split. Another date would be set for when trading begins on a split-adjusted basis.
Speaking of dividing up the pie, let’s take a look at Apple. In its 40-year history, Apple has split four separate times. In July 2020, the company announced that a fifth split would happen in August 2020.
- June 16, 1987: 2-for-1 split
- June 21, 2000: 2-for-1 split
- February 28, 2005: 2-for-1 split
- June 9, 2014: 7-for-1 split
- August 28, 2020: 4-for-1 split
If an investor owned one share before the June 16, 1987 split and kept their stock, they would own 224 shares after the stock splits 4-for-1 later this month.
Keep in mind that this does not mean that the stock has become cheaper. The fundamentals of the company and the stock price have not changed.
Same Pie, Bigger Slices: Reverse Stock Split
Now that you know what a stock split is, let’s take a look at the opposite of a stock split, a reverse stock split.
This is when the company divides the number of shares that investors own, rather than multiplying them. As a result, the price of the shares increases.
For instance, if you own 10 shares of Company X at $10 per share, and the company announces a one-for-two reverse stock split, you end up owning five shares of Company X at $20 per share. Just like a stock split, you need to be a shareholder by a certain date, specified by the company, to qualify for a reverse split.
One of the most famous examples of reverse stock splits is Citigroup (C). During the 2008 financial crisis, its share price fell below $10 and didn’t rebound unlike some of its competitors, so the board decided in 2011 to do a reverse split of one-for-ten. The split took the price from $4.50 per share to $45 per share. Today, the company’s stock is trading around $52 per share.
Rearranging Pie Slices: Why stock splits?
In most cases, companies decide on a stock split when the share price has gone up significantly, particularly in relation to a company’s stock market peers. Investors generally react positively to stock splits, partly because these announcements signal that a company’s board wants to attract investors by making the price more affordable and increasing the number of shares available.
In contrast, reverse stock splits are usually announced by companies that have low share prices and want to increase them. Companies will affect a reverse stock split so that their shares trade higher, with the intention of making them more attractive to mainstream investors and/or to ease the way to listing on a national exchange. For example, the Nasdaq has a rule stating that a stock is at risk of being delisted if its price is below $1.00 per share for 30 consecutive days.
Keep in mind that not all reverse stock splits are bad news for a company. Sometimes companies decide to reverse split their shares just because they want to offer their shares at reasonable prices to attract new shareholders, like Citi did in 2011.
Ultimately, for existing investors, the result is the same. The number of shares you own and their individual price may change, but stock splits (and reverse stock splits) don’t actually change the total value of your investment.
If you’re not yet an investor in a company, and a stock split has made its share price more affordable, you’ll want to to ensure it’s a good investment for your portfolio before you buy.