Your Money: Understanding Stock Splits

Stock splits: two words that are virtually guaranteed to prick up most investors’ ears. And so far, 2022 has been a banner year for splits – with Tesla, Amazon, Google and Shopify each issuing additional shares.

But what does that mean? And is a stock split always a good thing for investors? We’ll take a look.

First of all, what is a stock split?

A stock split is a corporate action that adjusts the number of shares outstanding in a company to increase or decrease the price per share.

New York Stock Exchange on Wall Street in New York City

There are two broad categories of stock splits: forward and reverse.

In a forward stock split, the company increases the number of shares to reduce the price per share of its stock. The board of directors of a company can choose to divide its shares according to any ratio; 2 for 1, 3 for 1, 5 for 1, etc. Although the number of shares outstanding increases, the total market capitalization of the company does not change since the price of each share divides equally. Each share is worth less because it now represents a smaller portion of company ownership. In other words, the size of the total cake remains the same – it was simply cut into several pieces.

A reverse split is just the opposite – in a stock split, the goal is to increase the price per share of the stock by combining multiple stocks into one more valuable stock. For example, if a stock is trading at $1 per share and the company institutes a 1-for-10 reverse stock split, investors would receive a single stock worth 10 times as much – in this case, $10 – for 10 shares they owned. This approach is often used by companies to cash out shareholders who hold less than a specified number of shares.

Futures splits are by far the most common, in part because the new lower price per share makes it easier for average investors to get the stock. With a futures stock split, the board is essentially hoping that increased interest and increased access to the stock will lead to more trades – and, therefore, a higher price.

In the short term, this new interest can create momentum since average investors can now invest in a company that was previously too expensive. But over the long term, the stock price will generally come back down to reflect actual performance. There is no guarantee that a stock split will increase the value of a company’s stock.

Here are some recent examples of forward stock splits:

You’re here : At the company’s annual meeting on August 4, Tesla shareholders approved a 3-for-1 stock split. This split took place after the market closed on August 24. (Tesla shares closed at $891.29 on the 24th and opened at around $302 on August 25.) Tesla completed a 5-for-1 stock split in August 2020, making it the second split in shares in just two years.

Amazon: In March, Amazon announced its first stock split since 1999. The 20-to-1 stock split (accompanied by a $10 billion stock buyback) went into effect June 6. The shares were worth $2,785 at the time of the announcement – ​​a gain of more than 4,500% since the 1999 split. The June 6 split led to an Amazon share selling for less than $1,000 for the first time since 2017.

Alphabet: Alphabet (Google’s parent company) conducted a 20-for-1 stock split after the market closed on July 15. This represented the tech giant’s second stock split after its 2-for-1 split in 2014 and reduced its trading price from around $2,200 to around $110 per share. (But the stock price has suffered since then, hitting a 52-week low of $96.87 for its Class A shares on Sept. 27.)

Shopify: Shopify completed a 10-for-1 stock split after the June 27 trading session. While e-commerce giants like Amazon and Shopify have certainly benefited from online consumer spending during the pandemic, there are concerns about the impact the current high inflation could have on online retailers.

So, are stock splits a good thing?

Stock splits do not add or subtract value. A forward split increases the number of shares outstanding, but the overall value of the company does not change. Generally speaking, forward stock splits are done when the price of a stock has risen to the point that it is unrealistic for new investors. Thus, a split is often interpreted as a positive sign – indicating current or potential growth in the wake of new investors. (That said, stock splits aren’t universally popular. A perfect example is Berkshire Hathaway CEO Warren Buffett. Even though the company’s A-shares now trade at over $400,000 each, he declined to split those shares.)

The bottom line: Although investors often react enthusiastically to short-term stock splits, it is important to remember that investing is all about evaluating the overall performance of a company. A stock split shouldn’t be the main reason to buy a company’s stock. Remember that the split does not affect the market capitalization of the company. Although there are a number of reasons a company might split its stock, none of them change the fundamentals of the company. So don’t try to time the market, don’t invest in something you don’t understand, and don’t be afraid to seek the help of a qualified wealth advisor.

Jennifer Pagliara, CFP, CTFA, is Executive Vice President and Financial Advisor at CapWealth. For more information, visit capwealthgroup.com.

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