Loading the player...
A:

All publicly traded companies have a set number of shares that are outstanding. A stock split is a decision by a company's board of directors to increase the number of shares that are outstanding by issuing more shares to current shareholders.

For example, in a 2-for-1 stock split, an additional share is given for each share held by a shareholder. So, if a company had 10 million shares outstanding before the split, it will have 20 million shares outstanding after a 2-for-1 split.

A stock's price is also affected by a stock split. After a split, the stock price will be reduced since the number of shares outstanding has increased. In the example of a 2-for-1 split, the share price will be halved. Thus, although the number of outstanding shares and the price change, the market capitalization remains constant.

[ Stock splits can be a confusing concept for those new to the stock market, but a failure to understand them can have a significant impact on your returns. If you're new to these terms and would like to learn more about becoming a trader, check out Investopedia's Trading for Beginners Course. You'll learn everything from basic terminology to building your own trading system with position sizing and risk management techniques built-in in over five hours of on-demand video, exercises, and interactive content. ]

Why Do Stocks Split?

A stock split is usually done by companies that have seen their share price increase to levels that are either too high or are beyond the price levels of similar companies in their sector. The primary motive is to make shares seem more affordable to small investors even though the underlying value of the company has not changed. This has the practical effect of increasing liquidity in the stock.

When a stock splits, it can also result in a share price increase following a decrease immediately after the split. Since many small investors think the stock is now more affordable and buy the stock, they end up boosting demand and drive up prices. Another reason for the price increase is that a stock split provides a signal to the market that the company's share price has been increasing and people assume this growth will continue in the future, and again, lift demand and prices.

In June 2014, Apple Inc. split its shares 7-for-1 to make it more accessible to a larger number of investors. Right before the split, each share was trading at $645.57. After the split, the price per share at market open was $92.70, which is approximately 645.57 ÷ 7. Existing shareholders were also given six additional shares for each share owned, so an investor who owned 1,000 shares of AAPL pre-split would have 7,000 shares post-split. Apple's outstanding shares increased from 861 million to 6 billion shares, however, the market cap remained largely unchanged at $556 billion. The day after the stock split, the price had increased to a high of $95.05 to reflect the increased demand from the lower stock price.

What Is a Reverse Stock Split?

Another version of a stock split is the reverse split. This procedure is typically used by companies with low share prices that would like to increase these prices to either gain more respectability in the market or to prevent the company from being delisted (many stock exchanges will delist stocks if they fall below a certain price per share).

For example, in a reverse 1-for-5 split, 10 million outstanding shares at 50 cents each would now become 2 million shares outstanding at $2.50 per share. In both cases, the company is still worth $5 million.

In May 2011, Citigroup reverse split its shares 1-for-10 in an effort to reduce its share volatility and discourage speculator trading. The reverse split increased its share price from $4.52 pre-split to $45.12 post-split and every 10 shares held by an investor was replaced with one share. While the split reduced the number of its shares outstanding from 29 billion to 2.9 billion shares, the market cap of the company stayed the same at approximately $131 billion.

How Do Stock Splits Affect Short Sellers?

Stock splits do not affect short sellers in a material way. There are some changes that occur as a result of a split that do affect the short position, but they don't affect the value of the short position. The biggest change that happens to the portfolio is the number of shares being shorted and the price per share.

When an investor shorts a stock, he or she is borrowing the shares, and is required to return them at some point in the future. For example, if an investor shorts 100 shares of XYZ Corp. at $25, he or she will be required to return 100 shares of XYZ to the lender at some point in the future. If the stock undergoes a 2-for-1 split before the shares are returned, it simply means that the number of shares in the market will double along with the number of shares that need to be returned.

When a company splits its shares, the value of the shares also splits. To continue with the example, let's say the shares were trading at $20 at the time of the 2-for-1 split; after the split, the number of shares doubles and the shares trade at $10 instead of $20. If an investor has 100 shares at $20 for a total of $2,000, after the split he or she will have 200 shares at $10 for a total of $2,000.

In the case of a short investor, he or she initially owes 100 shares to the lender, but after the split he or she will owe 200 shares at a reduced price. If the short investor closes the position right after the split, he or she will buy 200 shares in the market for $10 and return them to the lender. The short investor will have made a profit of $500 (money received at short sale ($25 x 100) less cost of closing out short position ($10 x 200). That is, $2,500 - $2,000 = $500). The entry price for the short was 100 shares at $25, which is equivalent to 200 shares at $12.50. So the short made $2.50 per share on the 200 shares borrowed, or $5 per share on 100 shares if he or she had sold before the split.

The Bottom Line

A stock split is used primarily by companies that have seen their share prices increase substantially and although the number of outstanding shares increases and price per share decreases, the market capitalization (and the value of the company) does not change. As a result, stock splits help make shares more affordable to small investors and provides greater marketability and liquidity in the market. (See also: Understanding Stock Splits.)

RELATED FAQS
  1. Can a mutual fund's shares split?

    Learn about mutual fund share splits and why they occur, including how splits and reverse splits affect share price and total ... Read Answer >>
  2. What are reverse stock splits?

    A reverse stock split is a corporate action in which a company reduces the number of shares it has outstanding by a set multiple. ... Read Answer >>
  3. How does a company decide when it is going to split its stock?

    Learn why some companies decide to split their shares, and understand how they think it helps the stock's liquidity and future ... Read Answer >>
  4. What happens to the value of a mutual fund when a stock splits?

    Find out what happens to the value of a mutual fund when a stock in its portfolio splits, including how stock splits work ... Read Answer >>
Related Articles
  1. Investing

    Stock Splits: A Closer Look At Its Effects

    Most trades, including short sales and options, aren't materially affected by a stock split. Still, it's important for shareholders to understand how these events impact various aspects of investing. ...
  2. Investing

    Don’t Let Stock Prices Fool You

    Find out why a stock with a six-figure share price can still be a good value.
  3. Investing

    Understanding Stock Splits

    Find out how stock splits work and how they affect investors.
  4. Insights

    Amazon Hits $1000

    Amazon.com Inc. has hit $1000 per share, but don't expect CEO Jeff Bezos to approve a split.
  5. Investing

    If You Had Invested In NVIDIA Right After Its IPO

    A $2,000 investment would have grown to nearly $275,000 since Nvidia's IPO in 1999
  6. Investing

    Should Chipotle Consider a Stock Split? (CMG)

    Learn why it might be good for Chipotle to enact a stock split. Discover why some investors are bearish on the company's prospects.
  7. Investing

    The Highest Priced Stocks In America

    These stocks don't come without a hefty price tag. But are they worth it?
  8. Investing

    If You Had Invested Right After AT&T's IPO (T)

    Analyze how AT&T stock has performed after the company's 1984 IPO, and learn how you would have fared had you been an early investor.
  9. Investing

    If You Had Invested Right After JPMorgan's IPO (JPM)

    Find out how much your investment would be worth in 2016 if you had purchased 100 shares during JPMorgan's IPO, including the impact of dividends and splits.
  10. Investing

    Why the UWTI Did a Reverse Split (UWTI)

    Discover why UWTI has performed a reverse split to increase the fund's price per share and why it is likely to happen again in the future.
RELATED TERMS
  1. Stock Split

    A stock split is a corporate action in which a company divides ...
  2. Split Close

    A situation that refers to price differences within a series ...
  3. Baby Berkshire

    Baby Berkshire refers to the 50:1 stock split after the market ...
  4. Split Limits

    A provision of an insurance policy that states different maximum ...
  5. Earnings Per Share - EPS

    Earnings per share (EPS) is the portion of a company's profit ...
  6. Combined Single Limits

    Combined single limits are a provision of an insurance policy ...
Hot Definitions
  1. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  2. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  3. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  4. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  5. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
  6. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company.
Trading Center