Stock Splits and How They Work
It seems that the second half of 2020 had been a popular time for large corporations to announce stock splits - (This blog is for information purposes only; it is not a recommendation to buy or sell any particular stock). This can be great news for investors looking to add these companies to their portfolio, but who may have not been able to in the past due to the higher prices. Here at FPS, we don't advocate buying into individual companies as that can carry more risk than a diversified portfolio. However, for those that already own shares of companies, this brief primer on stock splits, and what they mean for potential investors, current investors and the companies themselves offer some explanations.
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 pumpkin pie (stick with me here). Say you have a nice large pumpkin pie with eight pieces. Each of these pieces makes up a share of a company. If that company decides to do a stock split, that means that each piece of pie will be further divided.
If two of those pieces are yours and a 2-for-1 stock split is announced, those two pieces will be split into 4 smaller total pieces. The actual amount of pie that’s yours has not changed, it’s simply been divided up even further. This allows less-hungry investors to grab smaller pieces of pie, whereas before they’d have to take a whole piece if they wanted in on the pie.
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?
New Investors
Stock splits can be an appealing investment option for those who typically have smaller amounts of money to invest. 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.
Current Investors
The number of shares you own will increase, but their worth will decrease proportionately - meaning a stock split will not affect 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.
Publicly-Traded Companies
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 fewer 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.
As always, please feel free to reach out to me anytime for a conversation. Click HERE to see my calendar or just shoot me an email or give me a call.
In good health.
All the best.
Rick Fingerman, CFP®
617-630-4978
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. Financial Planning Solutions, LLC (FPS) provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client. Information herein includes opinions and source information that is believed to be reliable. However, such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.
This blog is for information purposes only; it is not a recommendation to buy or sell any particular stock