What is a Stock Split?

Key Takeaways

• A stock split basically divides each share into multiple shares.

• A forward split is when a company heightens its share count by issuing new shares to current investors.

• A reverse split is when shares owned by current investors are supplanted with a proportionately smaller share total.

There are several reasons why companies split their stocks. Read on to find out about the often employed strategy.

What is a Stock Split?

A stock split essentially divides every share into multiple shares. This is usually done to create lower-value shares that are more liquid and affordable.

Note, though, that when a stock split occurs, the number of outstanding shares rises. However, the company’s value as a whole goes unchanged. For investors, this means more shares at a reduced individual price, but a net investment value that remains the same.

How Does a Stock Split Work?

To illustrate, perhaps a company with 5 million outstanding shares intends to do a two-for-one stock split. That means it would have 10 million shares post-split. And as a result of the split, the company’s stock price would drop by half.

Why Do Companies Choose to Do a Stock Split?

There are a variety of reasons why companies would pursue a stock split. One common reason is to offset what they perceive to be a stock price that’s too high, relative to competitors or similar companies. The share’s increased liquidity due to the reduced price gives buyers and sellers increased flexibility. It also means that even high future trading volumes may not significantly affect the stock’s price.

Example of a Stock Split

Here is a recent high-profile stock split:

Alphabet (GOOG) announced a 20-for-one stock split, its first in eight years, effective on July 15, 2022.

Other Historical Stock Splits

• Coca-Cola. Throughout the 1960s and 1970s, in which there was much market volatility, Coca-Cola (KO) made three different two-for-one stock splits, plus a three-for-one split in 1986. There were also two-for-one splits in 1990, 1992, and 1996, with the last one in 2012.
• Amazon (AMZN) has undergone four stock splits since 1998 — which was a two-for-one split — with a 20-for-one split that went into effect on June 6, 2022.

What are Stock Split Ratios?

Such a ratio expresses the number of new shares that will be created following a forward split. Note that as long as the action is sanctioned by the company’s board and shareholders, a company may perform a stock split of any ratio, with 3:1 or 2:1 being the most common.

How Do Stock Splits Affect Share Prices?

A stock split has no impact on the value of one’s investment overall. Still, it may indirectly affect stock movement. For example, more people buying the stock due to its new affordability could drive up demand, which could cause an even higher stock price increase.

How Do Stock Splits Affect Shareholders?

A stock split does not – by itself — impact a company’s overall market capitalization. Instead, it is merely a modification of a company’s stock share count. Still, the circumstances regarding the stock split can affect stock movement.

What is key to understand is that the proportional ownership of an investor’s position is not affected by the split.

Considerations of a Stock Split

One should note that it is the market that will decide a stock split’s impact on a position’s total value. The split alone does not change investment value one way or the other.

Forward Stock Split vs. Reverse Stock Split

The terms traditional stock split and forward stock split are interchangeable. The opposite of a forward stock split is a reverse stock split. With the latter, the aim is to shrink its number of outstanding shares and raise share price proportionately. The company’s market value stays the same with a reverse stock split as well.

A company might do a reverse split if its share price drops to the point at which it risks an exchange delisting it. That can occur if a stock is not meeting the minimum price a listing requires.

Advantages of a Stock Split

• Stocks are more affordable and liquid, which could increase demand and result in increased prices.
• They demonstrate company leaders’ confidence in a stock price, which can spread to investors.
• For investors, stock splits by top companies are bullish signals.

Disadvantages of a Stock Split

• There is no guarantee a stock will rise following a split announcement. If the stock split is not followed by robust earnings or dividend growth, any gains made post-split would likely return to presplit levels, or below.
• The stock split process is expensive and must be performed in alignment with regulatory laws.
• It creates no additional value.

How Does a Stock Split Affect Company Value?

A company’s value is not directly affected by a stock split because the company’s fundamentals or growth potential were not changed as a result of the action.

How to Invest Outside the Stock Market

If investors focused more on diversifying their portfolio, they would not have to constantly respond as much to the ups and downs of the stock market. Financial managers and seasoned investors increasingly agree that it is likely wiser to include alternative investments such as art and real estate in holdings, as they can provide consistent secondary income and guard against inflation.

Alternative Investments and Portfolio Diversification

Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform. However, that meant the potentially exceptional gains these investments presented were also limited to these groups.

To democratize these opportunities, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

Summary

Ultimately, investors need not await a stock split to buy shares. Options also include assets that are outside the stocks and bonds class altogether. Rather than have a portfolio that is wholly dependent on ever-changing public markets, a better move may be to commingle it with secondary income-generating alternative investments.

All securities involve risk and may result in significant losses. Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.