What is a Stock Split and How Does it Work?

Investing

Nov 18

This post covers the basics of stock splits, how they work and impact your investment portfolio, and much more. Without further ado, let’s jump right in…

What is a stock split?

A stock split occurs when a company increases the number of its outstanding shares by offering additional stock to current shareholders, thus lowering the price per share.

What happens when a stock splits?

Stock splits are commonly of the “2-for-1” or “3-for-1” variety. For example, if a shareholder owns 10 shares of stock worth $100 ($10 per share) and the company decides to move forward with a 2-for-1 stock split, the shareholder will then own 20 shares of stock worth $100 ($5 per share) after the split.

Why companies split their stocks

Companies can decide to perform a stock split for several reasons, but the most common is the ability to raise additional capital more easily. This is often the case when stock prices are too high for the average investor and/or investors see little room for growth. A stock split makes the share price more enticing, boosting the chance additional people will invest in the company.

For example, back in 2020 Apple engaged in a 4-for-1 stock split while its stock was trading at nearly $500 a share: reducing the price to about $125 per share, making the stock affordable to more investors. In 2022, meanwhile, Amazon employed a 20-for-1 stock split when their stock was valued at almost $2,500 per share—resulting in a post-split price of $124—followed two years later by NVIDIA completing a 10-for-1 stock split when their stock price was trading at $1,200 per share (bringing the price down to $120).

Another benefit of stock splits is they can also spark a short-term share price increase since, in theory, lower prices help boost demand. According to Smartasset.com, stock splits tend to be good for this; research shows that generally after a split, stocks significantly outperform the S&P for the first 12 months thereafter.

Another popular reason to pursue a stock split is to increase liquidity, as splits make it easier for investors to trade stocks; the more expensive the stock, the longer it can take to sell shares.

Why some companies don’t split stock and potential impacts

Not all companies split their stock, as there is sometimes no compelling reason to do so, while others believe a higher stock price can give their company an air of prestige with perceptions of value outshining a lower price.

Berkshire Hathaway is probably the best example of this; its Class A shares have never split and are valued at nearly $500,000 per share, although the company does offer Class B shares (with fewer voting rights) so investors can also purchase shares at reasonable prices.

Stock splits do involve potential risk, especially if an unexpected financial event (e.g., a recession or other news that adversely impacts the company) immediately follows one. Why? Because this often drives down the price per share even more, perhaps spooking investors and/or—in worst-case scenarios—tumbling below listing requirements and thus plucking the company from the stock exchange while limiting its ability to raise capital.

What is a reverse stock split?

Companies can also do the opposite and replace existing shares with a proportionate number of smaller shares: known as a “reverse split.” For example, a “1-for-2” reverse split replaces two existing shares with one new one—meaning if you owned 100 shares of stock, you’d now own 50 at the same overall value.

Companies with low share prices often conduct reverse stock splits when facing the risk of an exchange delisting for not meeting the minimum price. In taking this action, they can boost their price and remain listed on the exchange. A reverse stock split can also help improve investor perceptions of a company and help keep the stock within a normal trading range.

In September 2024, Sirius XM Holdings Inc. went through a 1-10 reverse stock split. Why? To lift its stock out of the penny-stock range and become more attractive to investors as the company was set to spin off and become independent.

That same month, Allbirds (an apparel company) announced a 1-for-20 reverse stock split to get back in compliance with the Nasdaq minimum bid price requirement and thus avoid delisting.

Reverse/forward stock splits

Although less common overall, a company that wants to reduce the burden and administrative cost required to communicate with every investor may decide to eliminate smaller investors through what’s known as a “reverse/forward split.”

In doing so, the company performs two different stock splits: a reverse split conducted to reduce the overall number of shares (causing some shareholders who hold less than minimum requirements to cash out) followed by a split that increases the overall number of shares each shareholder owns.

Key stock split dates

Three important dates are associated with stock splits. The first is the “announcement date” when the company shares all related details including the split ratio (e.g., 2-for-1 or 3-for-1). Existing shareholders must own the stock on the “record date” to become eligible to receive new shares created by the split, while the “effective date” is when the stock split occurs and new shares hit investor accounts.

Fractional investing and stock splits

Depending on the trading platform (e.g., Robinhood, Stash, or SoFi Invest), investors can now specify how much money they want invest in a particular company rather than the number of shares they want to buy. For example, if you want to buy a stock valued at $1,000 but only have $200 to spend, you can buy one-fifth of a share: referred to as “fractional investing.”

When a stock splits, fractional investors are subject to the same multiplication as any other shareholder. That said, as fractional investing gains steam, it’s not preposterous to assume this could reduce the need for stock splits down the road.

Investor stock split implications

A stock split doesn’t change anything on a material basis for existing investors, who remain in the same exact position as before with the same percentage of ownership. Though they’ll own more shares, each will represent a smaller percentage of company ownership. That said, it is common for stock demand to rise post-split given more affordable shares; a bump in value may result, but there are no guarantees. For example, when Tesla issued a 3-for-1 split in August 2022, shares traded at $288 per share but were down almost 18% by the end of the next trading day.

The bottom line on stock splits

Any type of stock split has little, if any, impact on existing shareholders. However, these lower prices are sometimes very enticing to prospective investors. Questions about how and where to invest your money? Schedule a FREE discovery call with one of our CFP® professionals.

FAQs

Stock splits are neither good nor bad, but one primary advantage for investors is the lower price that results can make shares more affordable and potentially boost demand: helping share value increase more quickly to magnify growth via additional shares owned post-split.
Yes, but it’s not very common. Nevertheless, mutual fund investors can in fact benefit when individual companies engage in stock splits if the fund they own also owns those companies within its holdings.
As mentioned previously, stocks have historically significantly outperformed the S&P 500 within the 12 months that follow. However, there are no guarantees in this respect.