Understanding stock splits is key to understanding how shares of a company work. When a company announces a split, more shares become available for trading; however, your overall investment value remains the same.
Similarly, if you owned 1000 shares prior to a stock split, after it occurs you’d still hold exactly that number afterward either through forward or reverse splits.
What is a stock split?
Just like cutting up a pizza into slices, a stock split increases the number of shares a company owns on the market while decreasing the price per share. A two-for-one stock split gives each shareholder one additional share with prices being cut in half;
Forward splits may be undertaken when companies believe their stock to be too costly compared to its peers or in order to attract new investors. They also facilitate trading volumes by making it easier for investors to purchase shares from an organization.
Reverse stock splits may cause investors to react with suspicion and even pessimism, as it might signal that a company is struggling and needs artificially increasing their share price to escape financial trouble. Yet many businesses that undergo reverse splits have seen successful comebacks over time.
Why do companies do stock splits?
Companies often undertake stock splits to make their shares more attainable for investors, for instance if a company had 100 shares and decided to split them evenly, the price per share would drop to $50 while total value of all remaining shares remains the same, making their stock more accessible for smaller investors.
Companies often resort to stock splits in order to increase liquidity of their shares, though this process can be expensive and requires legal supervision in order to ensure everything goes according to plan.
Finally, companies may consider undertaking a reverse split to increase its per-share price as a last-ditch attempt to stay above a minimum threshold required for listing or inclusion in certain mutual funds. Unfortunately, this strategy often backfires, leaving shares stagnating or decreasing further after being combined – ultimately this depends on many factors including earnings potential and future prospects of the business.
How do stock splits affect the price of a stock?
Stock splits may alter the number of shares outstanding, but they won’t increase a company’s market value. A stock’s worth is determined by multiplying together its number of outstanding shares multiplied by its price per share and stays the same before and after any split occurs.
Only one variable changes: the total number of shares available for trading. This could help increase liquidity by making the stock more available to a wider pool of investors and potentially decreasing bid-ask spread.
A stock split may also play a psychological role in encouraging investors to purchase more shares. When stocks rise rapidly, some investors may see them as too expensive; by creating the perception that you’re getting more for your money through a split, investors may feel they’re getting better value out of investing with that company – potentially spurring additional growth and supporting higher valuation. Still, overall market conditions will dictate long-term performance of any given stock.
What is a reverse stock split?
Reverse stock splits are attempts by companies to raise their share price by decreasing the total number of outstanding shares on the market, usually when their share prices fall below certain thresholds and place them at risk of delisting from NYSE or Nasdaq exchanges.
Reverse splits are most frequently employed with penny stocks, which are frequently considered high-risk investments prone to scams and can significantly alter investor perception and lead to renewed selling pressure. While a reverse split doesn’t alter overall share value of a company, it could potentially reduce investor pressure through renewed selling pressure resulting from its application.
Reverse stock splits do not change your percentage ownership, but can dilute voting power among existing shareholders by issuing new shares. If your ownership was affected by such an action, any fractional shares that are now owned will be traded in for cash instead of holding them – although this may present minor inconvenience, it should have no lasting detrimental effects on your investment strategy.
