Loading the player...

What is a 'Stock Split'

A stock split is a corporate action in which a company divides its existing shares into multiple shares to boost the liquidity of the shares. Although the number of shares outstanding increases by a specific multiple, the total dollar value of the shares remains the same compared to pre-split amounts, because the split does not add any real value. The most common split ratios are 2-for-1 or 3-for-1, which means that the stockholder will have two or three shares, respectively, for every share held earlier.

A stock split is also known as a forward stock split. In the UK, a stock split is referred to as a scrip issue, bonus issue, capitalization issue, or free issue.

BREAKING DOWN 'Stock Split'

When a stock split is implemented, the price of shares adjust automatically in the markets. A company's board of directors makes the decision to split the stock into any number of ways. For example, a stock split may be 2-for-1, 3-for-1, 5-for-1, 10-for-1, 100-for-1, etc. A 3-for-1 stock split means that for every one share held by an investor, there will now be three. In other words, the number of outstanding shares in the market will triple. On the other hand, the price per share after the 3-for-1 stock split will be reduced by dividing the price by 3. This way, the company's overall value, measured by the market capitalization, would remain the same.

Market capitalization is calculated by multiplying the total number of shares outstanding by the price per share. For example, assume that XYZ Corp. has 20 million shares outstanding and the shares are trading at $100. Its market cap will be 20 million shares x $100 = $2 billion. Let's say the company’s board of directors decides to split the stock 2-for-1. Right after the split takes effect, the number of shares outstanding would double to 40 million, while the share price would be halved to $50, leaving the market cap unchanged at 40 million shares x $50 = $2 billion.

Reasons for a Forward Stock Split

Why do companies go through the hassle and expense of a stock split? For a couple of very good reasons. First, a split is usually undertaken when the stock price is quite high, making it pricey for investors to acquire a standard board lot of 100 shares. For example, Apple Inc. issued a 7-for-1 stock split in 2014 after its share price had climbed to almost $700 per share. The board of directors figured that the price was too high for the average retail investor and implemented the stock split to make the shares more accessible to a wider set of potential shareholders. The stock price closed at $645 the day before the split was activated. At market open, Apple's shares were trading at approximately $92, the adjusted price after the 7-for-1 stock split.

Second, the higher number of shares outstanding can result in greater liquidity for the stock, which facilitates trading and may narrow the bid-ask spread. Increasing the liquidity of a stock makes trading in the stock easier for buyers and sellers. Liquidity provides a high degree of flexibility in which investors can buy and sell shares in the company without making too great an impact on the share price.

While a split in theory should have no effect on a stock's price, it often results in renewed investor interest, which can have a positive impact on the stock price. While this effect can be temporary, the fact remains that stock splits by blue chip companies are a great way for the average investor to accumulate an increasing number of shares in these companies. Many of the best companies routinely exceed the price level at which they had previously split their stock, causing them to undergo a stock split yet again. Wal-Mart, for instance, has split its shares as many as 11 times on a 2-for-1 basis from the time it went public in October 1970 to March 1999. An investor who had 100 shares at Wal-Mart’s initial public offering (IPO) would have seen that little stake grow to 204,800 shares over the next 30 years.

Reverse Stock Split

A reverse stock split is the opposite of a forward stock split. A company that issues a reverse stock split decreases the number of its outstanding shares and increases the share price. Like a forward stock split, the market value of the company after a reverse stock split would remain the same. A company that takes this corporate action might do so if its share price had decreased to a level at which it runs the risk of being delisted from an exchange for not meeting the minimum price required to be listed. A company might also reverse split its stock to make it more appealing to investors who may perceive it as more valuable if it had a higher stock price.

Want to know more? Read Understanding Stock Splits.

RELATED TERMS
  1. Split Close

    A split close is a situation that refers to price differences ...
  2. Push Out

    A push out helps effect a stock split in which new share certificates ...
  3. Split Payment

    A split payment is a means by which payment for a single order ...
  4. Split Limits

    Split Limits is a provision of an insurance policy that states ...
  5. Order Splitting

    When brokers split up larger orders to qualify them for the Small ...
  6. Gift Splitting

    Gift splitting is a taxation rule that allows a married couple ...
Related Articles
  1. Investing

    Berkshire's Stock Splits: Good Buy Or Goodbye?

    Warren Buffett's Berkshire Hathaway recently split its stock. Is this a sign to buy?
  2. Investing

    Understanding Stock Splits

    Find out how stock splits work and how they affect investors.
  3. 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. ...
  4. Investing

    Understanding Stock Prices and Values

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

    Do Stock Splits Cause Volatility?

    Since stock splits decrease the stock price, do they also increase volatility because shares are traded in smaller increments? Investopedia examines assumptions about this increasingly common ...
  6. 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
  7. 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.
  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

    Under Armour Splits Stock Two-for-One (UA)

    On its own, the split is purely cosmetic and means nothing, given how well Under Armour has performed amid persistent competitive pressure.
  10. Investing

    If You Had Purchased $100 of Apple in 2002

    Discover just how much money an investor could have made with only a $100 investment in Apple Inc. stock initiated in 2002.
RELATED FAQS
  1. Understand the What and Why of Stock Splits

    A stock split is when a company increases the number of shares issued to current shareholders. Read Answer >>
  2. Does a stock split lead to the gapping up/down of the stock?

    If a company splits its stock, there will be no gapping of the stock due to the split itself. A stock split does not materially ... Read Answer >>
  3. Why are some shares priced in the hundreds or thousands of dollars, while other just ...

    The answer can be found in stock splits - or rather, a lack thereof. The vast majority of public companies opt to use stock ... Read Answer >>
  4. What happens to a stop order after a stock splits?

    A stop order (or stop-loss order) is executed when a security reaches a pre-determined price as a market order. Learn what ... Read Answer >>
  5. Does a Stock Dividend Dilute The Price Per Share as Would a Forward Stock Split?

    Determine if paying a dividend to shareholders dilutes the price per share. Find out how a stock split increases shares outstanding ... Read Answer >>
Trading Center