The Stock Split Explained

A stock split is an official corporate action and occurs when a company decides to split its current shares into more shares to increase its share's liquidity and value or into less shares to decrease the value of shares. A company will do this to increase the number of outstanding shares in the market or to increase the value of each share.

When a split occurs, the dollar value of the shares stays the same, though the price changes. When it splits, it doesn't add any real value to the stock.

Most splits occur in the forward direction, meaning for every share you own, you may get 2, 3, or a lot more shares. The price will lower respectively to where it equals where the original price per share was. So, if a stock price is $1,000.00 and it splits 2:1, the price will drop to $500.00 per share, but you will have 2 shares instead of 1. It will not change the amount of money you have invested in a stock.

There are reverse stock splits for the company to decrease the number of outstanding shares and to increase the price per share. This may be done by the company to avoid being removed from the exchange due to price dropping too low.

Why Do Companies Decide on Stock Splits?

There are many reasons why a company may want to decide on splitting stocks. The main one is psychological. Some investors may feel like a stock price is too high and don't want to pay that much for a share. Splitting to bring the price lower helps investors with less trading power start buying shares again. Think about Amazon for a minute. How many shares can you afford to buy? If they simply split the shares, the price would come down to a reasonable level where you can afford to buy a few shares.

It is also used by a company to increase a stock's number of outstanding shares (shares available to buy), otherwise known as liquidity. This allows more investors to buy shares.

There are no immediate financial benefits of splitting a stock for the company, but the future movement of the stock can provide a lot of value to the company a few years down the line.

Some people buy shares of stock when they hear about forward splits if it is a strong company with more growth potential. Take for instance Google. They climbed to a very high number, over $1,100.00 in fact with a price of around $598.00 per share. It was a 2 for 1 split in March of 2014 and caused a lot of controversy due to the way they did it. Now the stock is over $1,100.00 again and has had a performance of over 100% since the split.

Not all splits have the same outcome. Sometimes the split backfires and the lowered share price is perceived as lost value and people stop investing in it. The price then drops on the lower demand. Or sometimes the split stalls the stock's price and from then on it maintains a nominal price, plus or minus normal fluctuation.