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What are Stock Splits and How Do They Affect Investors and Traders?

TABLE OF CONTENTS

What are Stock Splits and How Do They Affect Investors and Traders?

What are Stock Splits and How Do They Affect Investors and Traders?

Vantage Updated Updated Fri, 2022 July 29 12:21

On 15 July 2022, Google’s parent company Alphabet will execute a 20-1 stock split. This follows similar stock split moves in 2022 by Amazon (20-1) and Shopify (10-1).

As a long-term investor or a day trader, it might make you wonder how would stock splits impact your investment plan, and whether such moments present the right trading opportunities.

Here’s what you may need to know about how stock splits work, and how your positions might be affected before, during and after a stock split.

Key Points

  • A stock split increases the number of a company’s shares and reduces the share price without changing the market capitalisation.
  • Companies may perform stock splits to enhance stock accessibility and liquidity, and sometimes to comply with exchange listing requirements.
  • For investors, stock splits may bring short-term volatility and trading opportunities, but long-term investment decisions should be based on comprehensive company analysis rather than the split itself.

What is stock split? 

As its name suggests, a stock split is the process a public company undertakes to divide existing shares by a certain ratio.

In effect, this process increases the number of shares issued, without altering the proportion of shareholders or the market capitalisation of the company.

For example, imagine there is a company with 1,000 shares issued, each worth $1,000. The market capitalisation of the company would be $1,000 x 1,000 = $1,000,000. If it performs a 2:1 stock split, there will now be 2,000 shares issued, each worth $500.

This means that for every share investors previously held, they would now hold two shares – with the value of their investment remaining the same, all things being equal.

Why do companies stock split? 

One common reason companies perform stock splits is to bring down their stock price. Since stock market trades need to happen in lots (of 100 or 1,000), a high stock price might be prohibitive for investors with less capital or those who would rather diversify their investment portfolio.

A stock split thus makes owning (smaller-size) shares of the company more accessible, which contributes to improving liquidity.

For companies that offer stock options to employees, stock splits would allow employees more flexibility in cashing out part of their stock holdings, as well as make it more affordable for employees to opt into exercising their stock options.

A side effect of stock splits by prominent companies is that it drives publicity after the announcement of a stock split plan and in weeks leading up to the stock split execution. The boost in investor interest is a welcome upside, but is unlikely to be a significant driver of stock split decisions.

Reverse Split and Forward Split 

Companies can perform two types of stock split: reverse split and forward split. 

Reverse split 

A reverse split, also called a stock consolidation, is when a company reduces the number of shares by merging multiple existing shares into a single share. For instance, in a 1-for-3 reverse split, shareholders exchange three old shares for one share with a proportionally higher price.  

Companies often execute reverse splits to boost their stock price. This can be done to meet minimum price requirements for exchange listings, regain compliance with regulatory standards, or create the appearance of a higher-priced stock. 

Forward split 

A forward split, also known as a regular split, is when a company divides its existing shares into multiple new shares. For example, in a 3-for-1 forward split, shareholders receive three new shares proportional to every one share they already own. The aim of a forward split is to increase the number of shares outstanding while proportionally decreasing the share price. 

Companies usually implement forward splits to make their shares more affordable and accessible to a wider range of investors. By lowering the share price, the company aims to attract new investors and potentially increase liquidity in the stock. 

To better understand forward split, let’s look at Amazon’s stock split history. Since its listing in 1998, Amazon has undergone a total of 4 stock splits. Here is Amazon’s stock split list. 

Stock split list

Date Split Multiple Cumulative multiple 
2022-06-06 20:1 x20 x240 
1999-09-02 2:1 x2 x12 
1999-01-05 3:1 x3 x6 
1998-06-02 2:1 x2 x2 
Table 1: Amazon historical stock split

This means that one Amazon share bought before the split in 1998 would equal to 240 Amazon shares today. 

Before its recent split in 2022, a share of Amazon stock was priced at $2,785.58. After the 20-for-1 split, it became $139.28 per share, making it far more affordable for the average investor. 

The Good and Bad of Stock Splitting 

While there is no significant impact on an investor during a reverse split – as there is no change in the company’s total market value – reverse splits are usually viewed negatively.  

This is often due to a company’s share price having declined significantly, putting them at risk of being delisted. 

On the other hand, forward splits are typically seen positively as existing shareholders acquire extra shares without incurring additional cost. Nevertheless, it could also be risky if the stock share price falls too much post-split.   

How does a stock split work 

There are four key dates on which key stages of the stock split process take place.

Announcement Date: This is when the company makes an official, public announcement of the stock split, disclosing details such as the stock split ratio and subsequent dates of the subsequent two stages.

Record Date: This is the cut-off date on which shareholders would need to be holding the company’s stock in order to be eligible for the issuance of new shares from the stock split. This date is more of a technicality, since investors can still buy or sell shares afterwards, with the right to receive additional shares would be transferred accordingly.

Effective Date: Abbreviated as the ‘ex-date’, this is the date on which the company’s stock begins trading on the exchange at its split-adjusted price.

Payment Date: Also known as the ‘pay date’, this is the date on which the stock split is officially completed. In accordance with the split ratio, new shares are transferred to investors and will be reflected in their brokerage accounts.

Notable stock splits in recent history 

On 25 August 2022, Tesla (TSLA) executed a 3-for-1 stock split. Prior to its split on 24 August, TSLA shares closed around $891. Post-split, shares were priced at approximately $302. This is the company’s efforts of making their common stock more affordable for retail investors.  

This marks the company’s second stock split in less than two years, following its previous 5-for-1 split in August 2020.  

What to do when stock split happens 

After a stock split, your number of shares will automatically reflect the split ratio, and the price per share will be adjusted accordingly.  

As an investor, you should closely observe market reactions to the stock split. Stock splits are often part of a company’s growth journey, and their impact might be more apparent over an extended period. In the short term, there could be increased trading activity and potential price volatility. This is due to adjustments in the supply and demand dynamics and traders responding to the revised share structure.  

Should I buy the stock before or after the split?

There is usually a lot of media attention and investor interest surrounding a stock split, which could work in favour of, or against the company. On one hand, it might drive renewed interest in the stock but on the other, it could come with additional scrutiny.

Regardless of what direction the stock price takes post-split, it is not uncommon to observe a short period of increased volatility where opportunists and traders alike have jumped on the bandwagon.

It is worth remembering that a stock’s sticker price is hardly the most important indicator investors and traders look at when planning their trades.

Day traders are more likely to examine trading volume data and attempt to discern momentum from trading charts. Long-term investors, on the other hand, might be more interested in the company’s growth prospects, industry trends, the strength of its balance sheets, and whether the management team is a good one.

So, while the media and pundits tend to make a big deal out of stock splits, it would be wise for serious investors and traders to tune out the noise and plan their trades with the same care and diligence they usually take.

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