What is a stock split?
A stock split is when a company decides to issue existing investors with additional shares for each stock that they already own. In effect, each investor’s existing shareholding is “split” into a larger number of shares, even although their overall holding in the company remains the same as before the split.
How do stock splits work?
For example, let’s say that a company has 100 million shares in issue and a share price of £5 per share, giving it a market capitalisation of £500m. It carries out a 2:1 (or two-for-one) split, meaning that investors end up with two shares for every one they originally had.
The total number of shares increases to 200 million and – all else being equal, though it frequently isn’t – the share price falls to £2.50. The market cap stays at £500m and an investor who previously owned 100 shares worth £500 will now have 200 shares worth the same. All financial ratios such as earnings per share and dividends per share will be halved.
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What are the pros and cons of stock splits?
Stock splits have no impact on the operating performance of a company. In practical terms, it’s just like cutting a pizza into 20 slices instead of 10 – there’s the same amount of pizza, just more slices.
From that point of view, it’s widely believed that stock splits improve liquidity, because smaller investors are more able or willing to trade lower-priced shares. This is one reason why splits are far more common in the US than in the UK, where individual share prices are rarely so high that they represent a hurdle to investors.
But the argument for this is not very compelling, even in the US: in practice, investors tend to buy or sell a certain value of shares (eg, £5,000) rather than a certain number (eg, 500), so it’s only if the price is very high (eg, £10,000 per share) that you’d expect a lower price to make a difference to how often it’s traded, particularly given that fractional share ownership is widespread these days.
The empirical evidence is mixed. Some studies suggest that any changes is short-lived and that the bid/ask spread – a more meaningful measure of liquidity than the number of shares traded – may actually deteriorate after a split.
The opposite of a stock split is a consolidation or reverse split, which happens when a firm reduces the number of shares in issue. These are less common and usually the sign of a company trying to make a very weak share price look better.
What are some notable recent or upcoming stock splits?
In August 2020, tech giants Apple and Tesla both issued 4-for-1 and 5-for-1 stock splits respectively on the same day. Amazon more recently announced a 20-for-1 stock split, its first since 1999, which will take place on 6 June, assuming it receives the green light at its 25 May annual meeting. More recently, Tesla has announced that it plans to split again.
