What Is a Stock Split and How Does It Impact Your Portfolio?
The price of a company’s stock is dictated by the market — the share price is at the intersection of what someone is willing to sell it for and what someone is willing to buy it at. But sometimes a company feels that its stock price is too high — or too low. When this happens, the company can split (or reverse split) the stock, altering the price.
What Is a Stock Split?
When a company considers its stock price to be too high, it can increase the number of outstanding shares, which effectively lowers the stock price. The company’s valuation remains unchanged, so more shares means a lower price per share.
Here’s an example. Suppose XYZ Corp.’s stock is selling at $1,000 per share. The company thinks it’s too pricey, so the board approves a 2-for-1 stock split. The company grants each shareholder an additional share for each share they already have. The value of each share is cut in half — to $500 each — since there are now twice as many shares.
If you had 100 shares of XYZ Corp. at $1,000 per share the day before the split, you now have 200 shares of XYZ Corp. at $500 per share. Your investment is still worth $100,000.
What Is a Reverse Stock Split?
Just as a stock price that is too high can be a deterrent to investors, so can one that’s too low. A price that’s too low can be an indication that the company is not doing well or that the stock is a risky bet. So companies will sometimes do a reverse stock split, in which they exchange one share of stock at a higher price for several shares at the current, lower price.
Suppose you own 100 shares of ABC Corp., which is currently trading at $6 per share. The company decides to do a 1-for-2 reverse stock split. You now own 50 shares of ABC Corp., but it’s trading at $12 per share.
What Is a 2-For-1 Stock Split
A 2-for-1 stock split is when you’re given two shares for every one share of a companies stock that you own. So if you had 50 shares from a company that decided to split their stocks into two, you’ll now have double that. There are some instances where companies will do 3-for 1 splits and even 4-for-1 and 5-for-1, but those ones are more unusual. Here are some stock splits that attracted a lot of peoples attention.
In 2014, Apple (Nasdaq: AAPL) split its stock 7-for-1 to bring the price from about $140 a share to about $20 a share. Six years later, the stock split again, this time at a 4-to-1 ratio. In all, Apple has split its stock five times in its history.
In 2020, Tesla (Nasdaq: TSLA) split its stock 5-to-1. This cut the electric car maker’s share price from about $2,250 per share to about $450 per share.
In 2003, Priceline.com, now known as Booking Holdings (Nasdaq: BKNG), went through a 1-to-6 reverse stock split, going from roughly $4 a share to about $25 a share. It seems to have worked out — as of Sept. 27, BKNG was trading at $2,476.52.
Why Would a Company Split Its Stock?
Companies might split their stock if they think the share price is too high for the average investor to think that it’s a good buy. It’s a little bit of a mind game, really, because as fractional investing becomes more common, there’s really no need to buy a whole share of a stock that is too pricey for you. But emotionally, it seems like you’re getting a better deal when you buy a share of Apple at $20 than when you buy it at $100.
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How Does a Stock Split Impact Your Portfolio?
Often, investors will get notified of a stock split and worry about how it will impact their portfolio. The short answer is that, at least from a technical perspective, it won’t. You will still own the same percentage of the company you did before the split, and your position will be valued at the same amount.
Keep in Mind
Stock splits are often undertaken more for emotional reasons than for technical reasons. And splits often result in a bump in the stock’s price, simply because more investors are interested in the stock at the new price than were interested at the old price. This increased demand can drive up the price of the stock, at least in the short term. In the longer term, the price will always revert to what investors believe the company’s value represents.
The Timing of Stock Splits
There are three dates to be aware of in the event of a stock split:
- Record date: The record date is the date on which you need to be a shareholder of record in order to participate in the split.
- Distribution date: The distribution date is the date you will be notified of the number of shares you now hold as a result of the split.
- Effective date: The effective date — sometimes called the ex-dividend date — is the date the shares begin to trade at the split-adjusted price.
For example, LMNOP Corp. declares a stock split with a record date of March 1, 2021, and a distribution date of March 12, 2021. The effective date of the split is March 15, 2021. So, shareholders who own LMNOP Corp. stock on March 1 will get a letter or email dated March 12 telling them how many shares they now have. On March 15, LMNOP Corp. shares begin trading at the new price.
Is a Stock Split Good or Bad?
A stock split, or a reverse stock split, is usually neither good nor bad over the long term. A split may allow some investors who thought they couldn’t afford the stock to get in on the action. A reverse split may indicate that a company is struggling and needs to shore up its share price to improve its outlook to investors. But a split does not change the company’s valuation, or the total amount the company is worth to investors — it merely changes the number of outstanding shares.
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