It seems that the second half of 2020 has been a popular time for large corporations to announce stock splits - including companies like Apple, Tesla and McCormick. This can be great news for eager investors looking to add these market titans to their portfolio, but who may have not been able to in the past.
Below is a brief primer on stock splits, and what they mean for potential investors, current investors and the companies themselves.
What Are Stock Splits?
Simply put, a stock split occurs when a company decides to split its current shares into more shares. This does not affect the total value of an investors' shares, it simply creates more of them. For instance, if one share at $100 was split into two shares, each share would be worth $50 - still equaling $100 total.
The Math Behind Stock Splits
Think about a pizza (stick with us here). Say you have a normal, large pepperoni pizza with eight slices. Each of these slices makes up a share of a company. If that company decides to do a stock split, that means that each slice of pizza will be further divided.
If two of those slices are yours and a 2-for-1 stock split is announced, those two slices will be split into 4 smaller total slices. The actual amount of pizza that’s yours has not changed, it’s simply been divided up even further. This allows less-hungry investors to grab a smaller slice of pizza, whereas before they’d have to take a whole slice if they wanted in on the pizza.
Stock splits can occur in a number of different ways: 2-for-1, 3-for-1 and 3-for-2. While the math can feel complicated, the stock split ratios are fairly self-explanatory:
2-for-1: If you owned one share before the split, now you own two.
3-for-1: If you owned one share before the split, now you own three.
3-for-2: For every two shares you owned before the split, you now own three.
Who Benefits From Stock Splits?
Stock splits can be an appealing investment option for those who typically have smaller capital to invest with. They make it possible for interested investors to buy stocks from popular companies whose stock values have skyrocketed over time. You may not have been able to invest in a company whose stock prices sit at around $600 per share, but when the stock is split and you can obtain a few at, say, $100 a share - this may become more doable.
The amount of shares you own will increase, but their worth will decrease proportionately - meaning a stock split will not affect your the total value of your current holdings. For example, if you owned one share that was worth $200 and a 2-for-1 stock split occurs, you now own two shares worth $100 each- for a total value of $200.
However, stock splits have the potential to be good news for current investors - as it indicates the company is opening the door for new investors, meaning it could be a push that drives the stock prices up. This, of course, is not guaranteed, but the potential is there for current investors to get excited.
And, of course, the company that decides to split their stocks has done so because they find it’ll likely be beneficial for their company. Here’s why:
As a company grows, releases new products and continues to profit, its stock values rise. And while this is good news for investors and the company alike, it’s possible that high stock prices begin to have a negative impact on the company’s market liquidity. Stock prices that grow too high become less-attainable for the everyday investor, meaning less people are choosing to invest in that company.
That’s why stock splits can be appealing for companies, because they allow more investors to buy shares at more affordable prices. Additionally, the announcement of a stock split can often cause excitement amongst new potential investors, drumming up interest and (potentially) boosting stock values. A recent NASDAQ report indicated that simply announcing a large cap stock split increased stock value by 2.5 percent.1
Stock splits can be an exciting opportunity that makes pricey stock shares more attainable for the everyday investor. If you’re considering adding stock splits to your portfolio, make sure to check in with your investment advisor first. He or she can help you determine whether this may be a beneficial, long-term move toward your larger financial goals.
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Paradigm Advisors is a fee-only financial planning firm based in Dallas, Texas and Fayetteville, Arkansas. Paradigm Advisors provides comprehensive financial planning and investment management services to help clients organize, grow and protect their wealth throughout life’s journey. Paradigm specializes in advising young professionals and entrepreneurs in the early stages of life and well-established career executives through financial planning and investment management. As a fee-only fiduciary and independent financial advisor, Paradigm never receives commission of any kind. Paradigm is legally bound by certification to provide unbiased and trustworthy financial advice.