Understanding Stock Splits: What They Mean for Investors
Several major companies, including Nvidia (NVDA), Chipotle Mexican Grill (CMG), Broadcom (AVGO), and MicroStrategy (MSTR), have made headlines this year with announcements of stock splits. Recently, Arista Networks (ANET) joined this trend as well. As we approach 2025, potential candidates for future splits, such as Microsoft (MSFT) and ASML Holding (ASML), have caught investor attention. Let’s revisit the concept of stock splits and their implications for Wall Street.
Defining Stock Splits
A stock split refers to a company’s decision to divide its existing shares into multiple shares. The most common type is a traditional stock split, such as a 2-for-1 split.
In a 2-for-1 split, for every share held, a shareholder receives an additional share. For instance, if a company originally has 1,000 shares and executes a 2-for-1 split, the total number of shares increases to 2,000.
Share value is adjusted accordingly; if each share initially costs $100, it will drop to $50 post-split. Importantly, while the per-share price decreases, the total market value of the company remains unchanged. A stock split reallocates existing shares but does not create new value.
Stock splits can also be executed in different ratios, such as four-for-one or eight-for-one. For expensive stocks like Shopify, which once traded close to $2000, a four-for-one split could have brought the price down to $500 per share, attracting more investors who might find the original price off-putting.
Understanding stock splits lays the foundation for discussing their opposite: reverse stock splits.
Explaining Reverse Stock Splits
A reverse stock split occurs when a company reduces the number of outstanding shares. For instance, a 2-for-1 reverse split would reduce 100 million shares to 50 million shares.
Following such a split, shareholders would own fewer shares, but each share would have double the value. If a share was priced at $100 prior, it would be valued at $200 afterward. Like traditional stock splits, reverse splits do not add or remove value from the company; they only adjust the number of shares available.
Companies might opt for a reverse split to boost the share price, potentially meeting exchange listing requirements that mandate a minimum share price.
Reasons for Stock Splits
Companies undertake stock splits for various reasons. One is to make shares more accessible for smaller investors. For example, if a company trades at $200 per share, some may find it daunting to invest. A 2-for-1 split drops the price to $100, encouraging broader investment.
Increased liquidity is another reason for splits. A lower share price can lead to more trades, as it becomes easier for investors to buy and sell the stock.
Additionally, stock splits can enhance a company’s attractiveness. When a stock trades at a high price, it may seem overvalued. A split can lower the price, giving the impression of a bargain for potential investors.
The effects of stock splits on shareholders can vary based on the underlying reasons for the split. If a split makes shares affordable, it typically benefits shareholders as increased demand can drive prices higher.
Additionally, enhanced liquidity from stock splits can allow shareholders to achieve better trading prices, leading to increased volume and potential profits.
While stock splits generally produce positive outcomes for investors, each situation is unique. Always conduct independent research before deciding to invest in a company, even after a split.
Investing in Stocks After a Split: What to Consider
Upon hearing about a stock split for a high-priced stock you’re watching, you might wonder, “Should I buy?” A split can positively influence shareholders, but it’s essential not to hastily invest simply due to the occurrence of a split.
Perform thorough research prior to buying any stock. Examine financial statements, the management team, the competitive landscape, and any factors that might impact the company’s performance.
Remember, stock splits are mere corporate actions and don’t inherently signify a company’s strength or guarantee sound investment. Some companies might even utilize splits as a misleading tactic before releasing negative news.
Conclusion: The Broader Perspective on Stock Splits
Stock splits can be intricate, but they serve a clear purpose. A split signifies that a company’s shares have become pricey for certain investors, prompting the division of shares to enhance affordability. This action changes neither the overall value of the company nor its fundamentals.
Overall, stock splits are often beneficial for shareholders, leading to increased demand and higher share prices. However, always prioritize fundamental analysis and due diligence in your investment decisions, irrespective of stock splits.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
