What is a stock split?
When a company decides to split its stock, it’s literally doing just that—breaking stocks into additional shares. Imagine you have a block of ice and want to break it into ice cubes; the concept is the same for stocks.
Public companies have a finite number of shares or a total number of shares that they can sell to their stockholders. A stock split increases the number of shares on the market by splitting the current outstanding shares into more shares.
How a stock split works
When creating a stock split, a company will pick a ratio—for example 2-for-1, 3-for-2, and so on. If the ratio is 2-for-1, then each share will be split into two.
A stock split will reduce the value of each share according to its ratio. For example, in a 2 for 1 split, each share will be worth 50% of the original, single share’s value. But shareholders don’t necessarily see their investment dilute, or lose value since the two new shares combined have equal value to the original share.
Typically, a company will split its stock when its share price has become so high that smaller investors can’t afford the price of a single share. Some companies today, for example, have stock prices in the hundreds, thousands, or even hundreds of thousands of dollars per share. By increasing the number of shares, or increasing supply, a public company can bring the stock price down without affecting a company’s total value.
Stock splits are common, and you can even see which companies have planned splits occurring on any given trading day. In recent years, a wide range of companies including Apple, Berkshire Hathaway, and Google have all split their stock.
When a company’s board of directors decides to split its stock, the company will issue an announcement outlining the details.
Reverse stock splits
A reverse stock split has the opposite effect of a regular stock split—it reduces the number of outstanding shares on the market.
When a reverse stock split occurs, each share is converted to a fraction of a share. For example, if you own ten shares, and a reverse stock split occurs that converts each share into 0.1 shares, your ten shares becomes one.
The result is fewer, but more valuable shares. A company may want to increase the value of its shares to avoid being delisted from stock exchanges, in the event that its share price is too low, or to boost its image.
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