Stock splits defined

You can’t predict how or when a stock split will take place before a company announces the move. But here’s why they happen and how they affect your portfolio.

What is a stock split?

A stock split takes place when a company divides its existing shares to make new shares. The result? Share prices drop — but the value of the stock remains intact. For example, let’s say you have 10 Apple shares and a 2-for-1 stock split takes place. Now you hold 20 shares. Your overall stake in the company hasn’t changed: only the number of shares you hold.

Stock split: A stock split occurs when a company divides its existing shares into multiple new shares in an effort to increase its liquidity.

Stock splits — also called forward splits — don’t affect the company’s market capitalization or the value of shares for existing shareholders. It just means there are more shares in circulation.

2 reasons for stock splits

Why would a company opt for a stock split? Simply put, splits help companies improve their stock in two ways:

1. Liquidity. Multiplying the number of shares in circulation has the immediate effect of increasing the overall liquidity of the stock. And increased liquidity can help increase trading volume, which is often a plus for the company.
2. Value. After a stock split, share prices go down — but this tends to be temporary. In fact, most stocks see their value rise post-split thanks to more traders investing at a lower price point.

The positive impact of stock splits on your portfolio

Is a stock split good news for your portfolio? Generally, yes. As an existing shareholder, the number of shares you hold will grow without you having to lift a finger. And while those shares will be lower in price than they once were, the value of your investment will remain unchanged. At least until trading picks up.

Ultimately, companies want to improve the value of their stock. And that’s one of the motivating factors behind stock splits. While there may be some initial volatility following the split, in many cases, shareholders see the value of their investments increase following the split.

Example of a stock split: Apple’s 7-for-1 split in 2014

Let’s circle back to Apple. Apple’s stock has split five times since its 1980 launch on the Nasdaq — and we’ve seen noteworthy results from each split.

Let’s say you were an Apple shareholder during its 7-for-1 stock split back in 2014. Before the split, you held five Apple shares worth $23.17 apiece for a total investment of $115.85. After the split? You would have held 35 shares — but your total investment of $115.85 would have remained relatively unchanged. At least at first.

Three months post-split, your Apple investment would have gone up by 6.7%. And one year post-split, your shares would be up 39%.

Note, though, that fluctuations in stock prices following a stock split may not be exclusively attributable to the split. There are plenty of things that hold sway over share prices. For example — a few months after its 7-for-1 stock split, Apple unveiled its first-ever Apple Watch. And that almost certainly attracted a new investor or two.

9 stocks and how they performed post-split

Many companies initiate stock splits with the intention of improving the liquidity and value of their stock. Here’s a look at some well-established companies and how their stock performed post-split.

Stock split vs. reverse stock split

A reverse stock split is what happens when a company decreases the number of shares in circulation.

For example, a forward 2-for-1 stock split results in each share being split in two. A 2-for-1 reverse stock split results in two shares being combined into one.

Companies use reverse stock splits for a number of reasons, but they’re often relied upon to boost the value of low-value shares and prevent companies from being delisted from public exchanges.

Fractional shares and stock splits

Do stock splits result in fractional shares? You bet. But how your broker deals with those fractional shares may differ.

If your broker offers fractional share investing, you may simply receive the appropriate amount of fractional shares. Or, your broker may give you the cash equivalent of any non-whole share amounts that resulted from the split. This is called cash-in-lieu (CIL).

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