What is a Stock Split? | CapWay
- A stock split is a corporate action in which a company divides existing shares into multiple shares to increase the number of shares outstanding.
- The total value of the stocks does not change, because the number of shares increase whilst the stock price decreases.
- Stock splits make purchasing stocks more affordable for most investors.
A stock split is a corporate action in which a company divides existing shares into multiple shares to increase the number of shares outstanding.
For example, if a company had 1 million outstanding shares and decided to do a 2-for-1 stock split, the number of outstanding shares would be doubled to 2 million. Each shareholder would receive an additional share for each share they owned before the split.
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Understanding Stock Splits
Assume that a shareholder-owned 100 shares of the company before the split. Following the split, they would own 200 shares (100 original shares + 100 new shares from the split). However, the shareholder's holdings would remain unchanged. If the company's share price was $100 before the split, its price per share would be $50, but the total value of the shareholder's holdings would remain $10,000.
A stock split does not affect a company's overall value or market capitalization, but it makes the stock more affordable for individual investors and increases stock liquidity. For example, a company with a high stock price may be too expensive for some individual investors, but a stock split can make the stock more accessible to a broader range of investors.
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Example of a Stock Split
As an example of a company that has done multiple stock splits, consider Apple Inc. (AAPL). Apple conducted a 7-for-1 stock split in 2014, which meant that for every share AAPL shareholders owned before the split, they received seven new shares. AAPL's stock price was around $700 before the split but dropped to around $100 afterward. In August 2020, Apple conducted a 4-for-1 stock split. AAPL's stock price was around $500 before the split but dropped to around $125 post-split.
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The Purpose of a Stock Split
Stocks and stock splits can serve various purposes depending on the company and its objectives. In general, stocks are a means for businesses to raise capital by selling ownership of the company to investors. When a company goes public, it issues shares that can be traded on public stock exchanges. If paid, investors who purchase stock become shareholders and are entitled to a portion of the company's profits, known as dividends.
Companies can use stock splits for a variety of reasons. First, as previously stated, a stock split can make a company's stock more affordable and accessible to individual investors, potentially increasing demand for the stock and driving up the stock price. This is especially useful for companies whose stock price has risen to a level that may discourage some investors from purchasing shares.
Second, a stock split can increase market liquidity by making more shares available for trading. This can increase the volume of shares traded and make it easier for investors to buy and sell shares.
Third, a stock split can signal a company's confidence in future growth prospects. A company that splits its stock effectively says that it expects its stock price to rise further and that it wants to make it easier for investors to buy shares.
The Money Wrap-Up
A stock split is a corporate action that divides existing shares into multiple shares to increase the number of outstanding shares of a company. Stock splits can increase market liquidity, make a company's stock more affordable and accessible to individual investors, and signal the company's confidence in its future growth prospects.
However, while stock splits can be beneficial in some cases, they do not always indicate a strong financial position or guarantee future growth. Therefore, you should always conduct your research and analysis before investing in any company, regardless of whether they have done a stock split.
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