The Complete Guide to Understanding Stock Splits

Stock splits have been in the news recently, as two notorious companies, Apple and Tesla, have announced stock splits. This may seem like a confusing idea; “how can someone split something that I own?” Well, we got you covered with all the quick basics you need to know.

What are Stock Splits?

A stock split occurs when a company decides to increase the number of shares, which results in a decrease in the cost of a share, without changing the market cap of the company.

For example, you own 10 shares of Company A. The shares currently trade at $80 each. Company A announces a stock split. The most common type of stock split is a 2:1. So for every single share you own, it will now double, but its value will halve. After the 2 for 1 split, you now own 20 shares of Company A, which currently trade at $40 each.

Before the split, you owned $800 worth of Company A (10 shares x $80 each). After the split, you now own $800 of Company A (20 shares x $40 each).

A stock split does not change the value of your holding.

Why Stock Splits Are Done

A company’s market cap does not change from a stock split. So why does a company go through all this for no change? It’s simple; to make their stock more attractive.

Let’s say Company B’s stock trades at $800 a share. They announce a 4 for 1 stock split. Now the stock trades at $200 a share. For investors who don’t want to put $800 into one company, they can now invest with as little as $200.

For the average investor who doesn’t have millions lying around to throw at companies, a stock split makes investing more accessible.

Apple and Tesla…Who’s Next?

Apple, the highest valued company in the world, recently announced a 4 for 1 stock split. On July 30th their stock price closed trading at $384.76. That afternoon they announced their stock split and quarterly earnings. The next day, July 31st, their stock closed at $275.04. They closed August 14th at $459.63.

Tesla stock has shot up like crazy since March. On August 11th, after the market closed, they announced a 5 for 1 stock split. Their stock closed at $1,374.39 on August 11th. After the announcement, the price jumped in after-hours trading. They closed the next day, August 12th at $1,554.76. They closed the week on August 14th at $1,650.71.

Now that it seems stock splits are back and a normal thing, who will announce one next? We’ve seen it helps the stock price in the short run. And there are several companies with very expensive price tags for one single share.

Alphabet’s, Google’s parent company, class A shares trade around $1,500 each. Amazon trades around $3,000 a share. Could either of these two giants be next?

Reverse Stock Splits

There is also something called a reverse stock split. As the name alludes to, it is the opposite of a stock split.

If a company believes their shares are too low and appear cheap, they will execute a reverse stock split.

For example, you own 50 shares of Company C’s stock, which trades at $3. They announce a 1 for 10 reverse stock split. You now own 5 shares, which trade at $30 each. In both cases, your value in Company C is $150.

In summation, neither a stock split or a reverse stock split changes the value of your holding. Generally, but not always, a stock split is considered good news and will lead to future gains, whereas a reverse split can be a worrying sign.