Explanation of what a stock split is, including examples from Tesla and Apple.

Stock splits explained

A stock split can be interesting for you as an investor. But what exactly is a stock split? Can you benefit from it? In this article, we explain this concept in more detail.

During the Internet boom in the late 90s, stock splits were commonplace. Stock prices rose so sharply during this period that publicly traded companies split their shares so that they remained affordable to private investors. Cisco did it regularly. Between 1991 and 2000, the software developer conducted no fewer than nine stock splits. It was also a tried-and-true method for Apple, with multiple splits.

What is a stock split?

The term "stock split"actually says it all. In this process, a company splits each share into smaller pieces at a certain split ratio, but the value of all the shares together remains the same. It’s a way for companies to boost their stocks’ liquidity. For example, if the company announces a 2-for-1 stock split, the share count doubles, and the share price halves.

How does a stock split work?

A stock split is a corporate action in which a company divides its existing shares into several shares with the aim of increasing liquidity and attracting new investors by reducing the unit value of the outstanding shares. The most common split ratios are 2-for-1 or 3-for-1, meaning that each shareholder receives two or three shares, respectively, for each share previously held.

When the share price of a listed company rises dramatically, the company usually proceeds with a stock split in order to lower the price and make it more attractive for investors. For example, an investor will feel more comfortable buying 100 shares at €10 rather than one share at €1000. By reducing the price per share, new investors will be able to buy the shares, potentially increasing the stock price. Stock splits can also increase the volatility of the share price. This often happens even before the actual split is exercised.

Example of a stock split

Company XYZ has 10 million outstanding shares and they are traded at a market price of €100. The market capitalisation is then €1 billion (10 million*€100). Suppose the company's board decides to do a stock split at the ratio of 2-for-1. Immediately after the split, the price automatically halves to €50, and the number of outstanding shares doubles to 20 million. The market capitalisation still remains €1 billion. If you had 10 shares worth €100 each before the split, you will own 20 shares worth €50 each after the split. You still have a total of €1000 worth of XYZ shares in your portfolio.

The most common split is 2-for-1. However, numerous ratios are possible. Think of 5:1, 7:1, 10:1, 3:2 et cetera. In the latter case, for every two shares the shareholder receives three new shares, or the outstanding number of shares increases by 50%. If you had 10 shares worth €60 each before the split, you will have 15 shares worth €40 each after the split. In order to carry out a split, however, the board of directors needs the consent of the shareholders, who can vote on it at the shareholders' meeting.

What is a reverse stock split?

Companies can also carry out what is known as a reverse split. This is basically the opposite of a stock split. In a reverse stock split, the number of outstanding shares is reduced and the par value per share is increased by the same factor. A reverse stock split does not change the market capitalisation of a company, nor does it change the shareholding of each investor.

Construction group Heijmans, for example, carried out a reverse split of 1:10 in 2009. In this process, 10 ordinary shares with a nominal value of €0.03 were combined into 1 ordinary share with a nominal value of €0.30. As we said, a reverse split also has no effect on a company's market capitalisation. If the share price is quoted at €0.03 on the day prior to the split, it will be €0.30 thereafter in this case. Shareholders with 1000 Heijmans shares would have 100 shares after the reverse split. The total value remains €30.

A reverse stock split is thus purely a cosmetic operation, which companies carry out because of the negative image of a low-priced share or penny stock. Such a stock is often a plaything of speculators and can therefore exhibit large price fluctuations.

Advantages and disadvantages of stock splits

Companies often choose an ordinary stock split from a position of strength. After all, a stock split generally takes place after the price of a stock has risen sharply due to, for example, a strong increase in profits or the prospect of future growth. Investors see the split as a positive signal that the profit outlook is also fine. After the split, there will be more room for a further price increase. Another additional benefit is that tradability improves, reducing the difference between bid and offer prices. The announcement of a stock split generally has a price-increasing effect. However, this is temporary. Ultimately, earnings per share is what drives stock prices in the long run.

However, the share split process is costly, requires careful legal oversight and must comply with regulatory requirements. In addition, it does not add any real value to the company because, as mentioned above, the value remains the same. Some public exchanges, such as the NASDAQ, also require the share price to be at or above $1. If the share price is below $1 for thirty consecutive days, the company must be recalled and has 180 days to return to compliance. Finally, a stock split can also attract the ‘wrong’ kind of investors. In fact, some companies deliberately choose not to proceed with the action in order to keep the shares exclusive.

Recent stock splits

Even today, we often see stock splits. For example, giants like Tesla, Apple, Amazon, and Alphabet decided to split their shares in recent years.

Tesla stock split

In August 2022 Tesla completed a 3-for-1 stock split. The trading price before the split was $891.29 per share, which became $297 after the action.

Apple stock split

Since the company went public, Apple’s stock has split 5 times. The most recent one is in 2020, a 4-for-1 split, from about $500 a share to $125 after the split.

Amazon stock split

Amazon announced a 20-1 stock split and a $10 billion stock buyback which went into effect on June 3rd 2022. It was the first stock split since 1999. At the time of the announcement the shares were worth $2,785, a gain of more than 4,500% since the prior split.

Alphabet (Google) stock split

Alphabet (Google) stock underwent a total of 3 stock splits. The most recent one occurred on July 18th, 2022 and it was a 20-for-1 split. Before the split, GOOGL shares were traded at $2,255.34, following the split the price was $112,64.

Warren Buffett

Shares that have been rising sharply in value for a long time are in danger of becoming unaffordable for private investors. There are stocks with a price of €10,000 or more. A well-known example are the Class A shares of Berkshire Hathaway, Warren Buffett's investment company, which is currently quoted at $548,364 (€501,201), as of November 2023. Closer to home in Europe, Swiss chocolate manufacturer Lindt & Sprüngli takes the crown, with a share price of nearly € 111,515 , as of November 2023.

For investors with a smaller budget, these shares are out of reach. This is also the reason why Warren Buffett's investment vehicle is not included in important stock indices such as the S&P 500. However, the world-famous investor has never wanted to split his share. Indeed, a split would go against his renowned buy-and-hold investment strategy. According to Buffett, a high share price ensures that speculators looking for a quick profit stay away.

Nevertheless, Berkshire Hathaway introduced the so-called B shares in 1996. These represent one fifteen-hundredth of a regular share and therefore have a much friendlier price tag of $361,12 (€330,06) at the time of writing. Thus, Buffett's investment company is still accessible to the small private investor.

Key takeaways

  • A stock split is when a company splits each share into smaller pieces at a certain split ratio to boost the stock’s liquidity, but the value of all the shares together remains the same.
  • The most common split ratios are 2-for-1 or 3-for-1, meaning that each shareholder receives two or three shares, respectively, for each share previously held.
  • In a reverse stock split, the number of outstanding shares is reduced and the par value per share is increased by the same factor.

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The information in this article is not written for advisory purposes, nor does it intend to recommend any investments. Please be aware that facts may have changed since the article was originally written. Investing involves risks (e.g., price volatility, currency or liquidity risk We advise you to only invest in financial products that match your knowledge and experience. Past performance is not a reliable indicator of future results. Markets are volatile and can fluctuate significantly due to economic, political, regulatory, or other developments.

Sources:Investopedia, FD, Forbes, Forex.com, Apple.com, Companies Market Cap

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