Understanding a stock split

A stock split happens when a company increases the numbers of its outstanding shares by a specific multiple. As a result of the split, the company’s market capitalization (the total dollar market value of a company’s outstanding shares of stock), isn’t affected.

For example, let’s say you own 10 shares of a company which decides to execute a 2:1 stock split. The total number of shares of the company is 1,000,000, and each share is trading at $100 in the market. On the day the split becomes effective, each share will be split into two shares, and you’ll now own 20 shares of the company. The total number of outstanding shares will now be 2,000,000, and the market price of each of those new shares will be around $50, since the company itself didn’t gain or lose value. The most common split ratios are 2:1 or 3:1, however recently we’ve seen split ratios as high as 10:1 or more.

Stock splits lower the price of a single share, often with the intention of increasing the perceived affordability of a share and therefore its liquidity.

For example, most investors would prefer to purchase 3 shares of a $200 stock versus 1 shares of a $600 stock. Increased liquidity may also decrease the cost of trading a single share, which can help companies repurchase their own shares at a lower cost.

Stock splits by large “blue-chip” companies are sometimes seen by investors as a bullish signal given the increased perceived affordability of the stock, however it should be noted that there is no fundamental change in a company’s fair value after a stock split!

Considering that a stock split has no fundamental impact on a company’s value, the process of a split is complicated, expensive, and highly regulated.

Some investors believe stock splits should be avoided to maintain the exclusivity of certain stocks. Splitting a stock and increasing its liquidity in the marketplace may diversify the pool of stockholders who own a portion of the company.

If a company does a stock split and their share price falls below $1 for 30 consecutive days, they risk being delisted from certain public exchanges.

The company is required to notify the Securities and Exchange Commission (SEC) before it splits its shares, and it will generally make a formal public announcement to alert its shareholders too. Don’t panic. You don’t need to take any action.
Your taxes won’t be affected. Your tax basis for each share owned after the split will be adjusted based on the ratio of the split, and your total won’t be affected.*
Stock splits don’t inherently make a company any more or less valuable, and your voting rights as a shareholder won’t be affected.
Your ownership percentage before and after the split is identical. You’ll own more shares, but each share is worth a smaller percentage of the company.
Sometimes there’s increased interest–and an uptick in price–in a stock after a split (likely due to its increased liquidity), but usually things return to normal within a few days.

If you have the Atom Finance app, you can access real-time data, news, and insights about companies and stock splits from your smartphone or desktop. If you don’t have the app, try it for free.

*Consult a tax advisor and see this resource from the IRS for more information.

Understanding a stock split

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