Definition
Stock splits occur when a company increases its number of outstanding shares by issuing more shares to current shareholders. It essentially divides the existing shares into multiple shares to reduce the trading price, making the shares more affordable for investors. Despite the increase in total shares, the overall value of the company does not change, maintaining the same market capitalization.
Key Takeaways
- A Stock Split is a corporate action where a company increases the number of its shares by dividing its existing shares. This does not change the total market capitalization as the proportional value of each shareholder remains the same.
- The primary reason for a share split is to make the stock seem more affordable to small investors. This can increase liquidity, as more investors can buy shares due to the lower price, leading to increased trading volumes.
- A stock split itself does not inherently add any value, but it often is interpreted as a positive signal by the market, as it can indicate that the company has been doing well enough to consider a stock split.
Importance
The finance term, Stock Splits, is crucial as it significantly influences a company’s stock price and the number of shares it has in circulation.
A Stock Split is a corporate action that increases the number of shares a company has on the market by dividing its existing shares into multiple new ones.
It’s important because it helps increase liquidity, makes stocks more affordable for investors, and can potentially attract a larger pool of shareholders.
Despite the fact that a split does not alter a company’s total market value, it can help boost the stock’s overall visibility and demand by lowering the individual share price.
Understanding Stock Splits is therefore key to identifying potential changes in market activity and shaping an effective investment strategy.
Explanation
A stock split is a strategic corporate action taken by a company’s board of directors to increase the number of shares that are in circulation. Essentially, a stock split redistributes the value of the shares; while the total market capitalization remains the same, the price of individual shares decreases proportionately.
Executed correctly, a split can lower the entry barrier for new investors, increase liquidity, and potentially positively impact the stock’s price through broadened demand. Companies usually use stock splits as a strategy when the share price becomes too high, potentially limiting the number of willing investors.
By lowering the price of each share but increasing the number of shares, they can maintain the overall company’s worth while making it more affordable for a wider range of investors to buy into the company. For example, if a company declares a 2 for 1 stock split, a shareholder with 10 stocks priced at $100 each will now own 20 stocks priced at $50 each.
Thus, the company retains its market cap, while the stocks become more affordable and attractive to small investors. Companies also perceive stock split as a signal of strong future prospects, hence generating positive sentiment among investors.
Examples of Stock Splits (Definition, Examples) | Reason for Share Split
Stock Splits Definition:Stock Splits are a corporate action where a company increases the number of shares in circulation by issuing more shares to its current shareholders. This is a way for companies to make their shares more affordable to smaller investors without affecting the company’s overall market capitalization. Now, let’s look at three real-world examples:Apple Inc: Apple (AAPL) is well-known for its frequent use of stock splits. In 2014, the company executed a seven-for-one stock split, meaning that for each share an investor owned, they received six additional shares. As a result, the share price dropped from around $700 per share to about $100 per share, making it more attractive and affordable for small investors. Again, in August 2020, Apple executed a four-for-one split, also meant to make the stock more accessible to a larger number of investors.
Tesla, Inc:In August 2020, Tesla (TSLA) announced a five-for-one stock split. Before the split, Tesla’s share was trading at around $1,39, which was reduced to $
88 post-split. This allowed more small investors to invest in Tesla, leading to an increase in its overall shareholder base.Amazon.com Inc:While Amazon (AMZN) has not recently conducted a stock split, they undertook three splits in quick succession in the late 1990s. In June 1998, they implemented a two-for-one split, followed by a three-for-one split in January 1999, and another two-for-one split in September
At both instances, split resulted in making the stock more affordable for the average investor, thus widening the investor base. The main reason for these companies to opt for share splits, despite the fact that it doesn’t change the company’s overall value, is to keep their individual share prices affordable for regular investors and thus increase liquidity.
FAQs on Stock Splits (Definition, Examples) | Reason for Share Split
Q1: What is a Stock Split?
A stock split is a corporate action by a company’s board of directors that increases the number of outstanding shares by dividing each share, which in turn diminishes its price. The stock’s market capitalization, however, remains the same, just like the value of money does not change if you change a $10 bill for two $5 bills.
Q2: Can you give some examples of stock splits?
Some of the most popular examples of stock splits include Apple’s 4-for-1 split in August 2020, and Tesla’s 5-for-1 split in the same month. In both these cases, the companies split their shares to make them more accessible to investors.
Q3: What is the reason for a share split?
A company may decide to split its shares for several reasons. The major reason is usually to make the shares more affordable to small investors. Splitting the shares decreases the individual share price and increases the number of outstanding shares. This can potentially increase overall liquidity for the stock.
Q4: Is a stock split good or bad for investors?
A stock split by itself does not inherently make the company any more valuable. However, a split can often be interpreted as a positive signal by the market because it suggests the company’s share price has been rising. This can attract more investors, which increases demand and can potentially further increase the share price.
Q5: How does a stock split affect the company’s Market Cap?
A stock split does not alter a company’s total market capitalization. Market capitalization is calculated as stock price times number of shares outstanding. In a stock split, as the number of shares increases, the price per share decreases correspondingly – keeping the market capitalization constant.
Related Entrepreneurship Terms
- Dividend Payment: This is the distribution of some of a company’s earnings to a class of its shareholders, as determined by the company’s board of directors.
- Par Value: This is the face value of a bond or stock as fixed by the issuing company, and doesn’t fluctuate with market value.
- Reverse Stock Split: This is a type of corporate action which consolidates the number of existing shares of corporate stock into fewer, proportionally more valuable, shares.
- Dilution: This refers to reduction in the ownership percentage in a certain company as an effect of the increase in the number of shares.
- Earnings per Share (EPS): It’s the portion of a company’s profit allocated to each outstanding share of common stock, serving as an indicator of a company’s profitability. The effect of a stock split will make the EPS appear smaller as the number of shares increases.
Sources for More Information
- Investopedia – A comprehensive resource for investing and personal finance education. This site often provides detailed explanations, examples, and reasons for various financial concepts including stock splits.
- The Balance – A personal finance website that has in-depth articles about investing, financial planning and other topics related to finance and economics, including stock splits.
- The Motley Fool – A financial and investing advice company that provides various resources about all things finance, including discussions about stock splits.
- MarketWatch – A financial information website that provides business news, analysis, and stock market data, and it covers topics like stock splits in detail.
