Stock splits are a capital operation method for a company to adjust the number of its outstanding shares. Although it will not change the company's total market value, it will affect the number, price and market perception of the stock.
This article will explore in depth the meaning, types, reasons, processes, and impacts of stock splits on investors.
Basic Concepts of Stock Split
A stock split is essentially a company's adjustment of the number of its issued and outstanding shares, during which the company's overall market value and total capitalization remain unchanged.
Figuratively speaking, a company is like cutting a fixed-size "cake", that is, the total market value, into more or fewer small pieces, that is, the number of shares changes, but the total value of each "cake" does not change.
Suppose a company has a total market value of 1 billion yuan and originally issued 100 million shares at a price of 10 yuan per share. If the company implements a stock split and doubles the number of shares to 200 million shares, the corresponding price per share will become 5 yuan, and the company's total market value will still be 1 billion yuan.
Types of Stock Splits
1. Forward Stock Split
A forward stock split is when a company increases the number of shares outstanding by issuing new shares to existing shareholders in proportion to their existing shares. For example, if an investor holds 50 shares of a company before the split, the number of shares held will become 100 after the split takes effect.
After a positive stock split, the number of shares of a company increases and the price per share decreases, but the company's overall market value does not increase or decrease. This is like cutting a large cake into more small pieces. The total amount of the cake remains the same, but the size of each small piece becomes smaller. Positive stock splits are common in the market, and many companies will use this method to adjust their stock prices.
2. Reverse Stock Split
A reverse stock split is the opposite of a forward stock split, which is to reduce the number of shares held by existing shareholders by a certain ratio. For example, a 1-to-4 reverse stock split means that for every 4 shares held by a shareholder, they will be consolidated into 1 share. If an investor holds 80 shares of a company before the reverse split, he will only hold 20 shares after the split.
A reverse stock split is usually implemented after a company's stock price has continued to fall sharply. The company hopes to improve its image in the market by reducing the number of shares and increasing the price per share, avoid being delisted from the exchange due to low stock prices, or increase the company's attractiveness in the eyes of investors.
Stock Split Ratio
The stock split ratio specifies how the number of shares will change after a stock split.
For example, a 3 : 2 stock split ratio means that for every 2 existing shares, 3 shares will be split. For investors, this ratio not only gives a clear understanding of the change in the number of shares, but also allows them to determine whether it is a forward or reverse stock split. When the first number in the ratio is greater than the second number, it is a forward stock split; conversely, when the first number is less than the second number, it is a reverse stock split.
By using the stock split ratio, investors can accurately estimate how the number of shares they hold will change after the split.
Reasons for the Company to Implement Stock Split
1. Enhance stock liquidity
Lower stock prices can attract more investors to participate in trading. Some small investors may not be able to buy high-priced stocks due to limited funds. Companies conduct positive stock splits to lower the stock price, allowing more investors to participate, thereby increasing the trading volume and liquidity of the stock. When the price of a stock is too high, many small investors are discouraged. By lowering the stock price through a stock split, these investors have the opportunity to buy, thereby increasing the trading activity of the stock.
2. Send positive signals
When a company implements a stock split , it sends a signal to the market that management is confident in the company's future development. This implies that the company believes that its performance can continue to grow, and even if the number of shares increases, the earnings per share will not be greatly affected. This positive signal will affect investors' psychological expectations, attract more investors to pay attention to and buy the company's stock, and drive up the stock price. When a company announces a stock split , investors may think that the company has good development prospects in the future, thereby increasing demand for the stock.
3. Adjust the stock price range
Maintaining a reasonable stock price range helps a company's stock remain competitive in the market. If the stock price is too high, it may limit the investor base; if the stock price is too low, it may give investors the impression that the company is poorly managed. Through stock splits, companies can adjust the stock price to a more appropriate level and enhance the market's recognition of the company. Some growth companies will split their stocks after their stock prices have risen sharply to keep the stock price within a relatively reasonable range and attract more investors.
Three Dates to Watch for Stock Splits
1. Announcement Date
The company will officially announce the stock split plan on this day, including key information such as the split ratio and the expected effective date. This announcement is like a preview of an event, allowing investors to know the company's stock split arrangement in advance and prepare for subsequent investment decisions. After investors learn about the company's stock split plan on the announcement date , they can adjust their investment strategy according to their own situation.
2. Record the date
This is the date that determines which shareholders are eligible to receive the new shares resulting from the stock split. Only shareholders who are registered on the record date are entitled to the new shares. However, if investors buy or sell shares between the record date and the effective date, the rights to the new shares will transfer with the trading of the shares. The record date is like a time point to determine the range of shareholders who will enjoy the benefits of the stock split.
3. Effective Date
On this day, the stock split officially takes effect, the number of shares in the shareholder's account will be adjusted according to the split ratio, and the stock price will change accordingly. Investors can see the newly added shares in their accounts on the effective date, and the shares will be traded at the adjusted price. The effective date is the day when the stock split plan is actually implemented, and the number of shares held by shareholders and the stock price will change substantially on this day.
Stock Split Case
Alphabet: Announced a 20-to-1 stock split on February 1, 2022, the company's first stock split in eight years. The split plan will split the company's Class A, Class B, and Class C shares in the form of a one-time special stock dividend.
Nvidia: On May 22, 2024, it announced a stock split plan, and its stock will be split at a ratio of 1:10 . After this stock split, the value of each Nvidia stock will drop from the original higher price to about one-tenth of the original price, and each Nvidia stock held by investors will become 10 shares.
Apple: Announced a 4-for-1 stock split on July 30, 2020. The board of directors approved the plan, and each shareholder of record at the close of business on August 24, 2020, will receive three additional shares for each share held on the record date.
Impact of Stock Splits on Investors
A stock split itself does not change the total value of an investor's investment. Whether it is a forward or reverse stock split, in theory, the total market value of the shares held by an investor does not change.
However, in the real market, stock splits often cause fluctuations in market sentiment, which in turn affects stock prices. A positive stock split may drive up the stock price by attracting more investors to buy; a reverse stock split may also have a positive impact on investors if it successfully increases the stock price. However, if the market does not respond well to the stock split, the stock price may also fall.
When faced with a stock split, investors should consider the company's fundamentals, market environment and other factors to make reasonable investment decisions.
