Stock Split: 5 questions answered

Amazon announced a stock split. Ruth Saldanha, Editorial Manager at Morningstar.ca, explains what a stock split is in detail.
By Morningstar |  10-03-22 | 
 

Amazon has announced plans for a 20-1 stock split, which if approved by shareholders, would take effect on June 6. That means for each share of Amazon you own, you would get an additional 19 shares.

This is not the first time Amazon has split its stock. It previously did a 2-for-1 split (1998 and 1999) and a 3-for-1 split (1999 again).

In February, Alphabet announced plans for a 20-for-1 stock split. Alphabet had split stock before – in a 2-for-1 split in 2014.

Apple previously split its stock on a 7-for-1 basis (June 2014), a 2-for-1 basis (February 2005, June 2000, June 1987), and a 4-for-1 basis (2020).

In 2020, Tesla announced a 5-for-1 stock split.

In India, some of the stock stock splits this week are Nouveau Global, BCL Enterprises and Mauria Udyog.

What is a stock split? 

Just math.

A stock split is exactly what it sounds like. One share gets divided, or split, into multiple shares. Don’t worry, though. The value of your holdings is the same, just in smaller chunks.

Think about it like a chocolate bar that gets broken down into multiple bite-size pieces. You still have the same amount of chocolate, just in smaller pieces.

Similarly, in a stock split, it is very important to remember that the price of the share also is reduced. For example, if a company board announces a 2-for-1 split, then you get one extra share for each share you own. But the share price will be halved. If you had one share of Company X at Rs 100 per share, you now have two shares of Company X at Rs 50 per share.

Does it mean that the fundamentals of the company have changed?

No. This does not mean that the stock has become cheaper in terms of valuation. Neither does it mean that the fundamentals of the company have been altered. Sticking with the chocolate bar analogy, after breaking the bark into smaller bits, you have smaller bits of chocolate, not more chocolate overall. 

Does it mean that the market cap of the company has changed? 

No. Though the number of outstanding shares changes, and though the price of each share changes, the overall market capitalization of the company stays the same. The value of the company doesn’t increase when a split occurs, therefore the value of your stocks, your shares, doesn’t change, either.

What is the reason for a company to announce a stock split?

Stock splits are a way for companies to increase the overall liquidity.

Liquidity means the ease with which investors can buy or sell shares on a stock exchange. The smaller the rupee amount of each share, the smaller number of shares are needed by even the smallest investor to buy or sell that stock.

In most cases, stock splits are undertaken by companies when the share price has gone up significantly, particularly in relation to a company’s stock-market peers. If the share price becomes more affordable for smaller investors, it can reasonably be assumed that more investors will participate, and so the overall liquidity of the stock would increase as well.

Take Alphabet for example. It closed on February 1 at $2572.88. Many investors would not be able to invest in Alphabet. Now if the stock split were to happen as of that day’s close, the cost of each share would go from $2572.88 to $128.64, and each existing holder would get 19 additional shares for every share they own.

A stock price of $128-odd would be much more manageable.

This is especially true now with more and more investors having access to low-cost trading platforms. Buying and selling stocks is now easier than ever, and for many investors, these recent splits might be an entry point for companies they have long admired.

All of this being said, these recent high-profile splits seem superfluous given that most brokerage platforms now enable trading in fractional shares. Perhaps the psychology of owning at least one whole share is at play in the companies’ decisions.

But additional participation by smaller investors could also lead to the price increasing, which we saw in the prices of both Apple and Tesla immediately after the stock split announcement.

“When we strictly observe the value of an investment immediately after a stock split, there really isn’t a discernable pattern in the change in wealth. What is noticeable is the trading volume of the stock which might be attributed to news flow,” points out Morningstar Canada’s Director of Investment Research Ian Tam. 

What is a reverse stock split?

The opposite of a stock split is a reverse stock split.

In the case of reverse stock splits, the company divides the number of shares that investors own, rather than multiplying them. As a result, the price of the shares increases.

For instance, if you own 10 shares of Company X at Rs 10 per share, and the company announces a 1-for-2 reverse stock split, you end up owning five shares of Company X at Rs 20 per share. Usually, reverse stock splits are announced by companies that have low share prices and want to increase them.

You may think that reverse stock splits are bad news for the company, but this is not always the case. One of the most famous examples of reverse stock splits is Citigroup. Its share price declined to under $10 during the 2008 financial crisis and stayed there, so the board decided in 2011 Citigroup to do a reverse split of 1-for-10. The split took the price from $4.50 per share to $45 per share. The company—and the stock—survived and is now trading at around $52 per share.

See, just math!

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ninan joseph
Mar 19 2022 10:10 PM
 Any clue as to why the term Bonus is used when Corporates issue Bonus shares.

The number of shares increases, but the market value falls proportionately then why is the term Bonus is used.
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