Stock Splits and Reverse Splits

Stock splits change the number of shares outstanding without changing the company's value. Understanding splits helps you interpret price movements correctly. [DEFINITION] Stock Split: A corporate action that increases the number of shares outstanding by issuing more shares to existing shareholders proportionally, reducing the price per share while maintaining total value. ### How Stock Splits Work In a 2-for-1 split: - You own 100 shares at $200 = $20,000 total value - After split: 200 shares at $100 = $20,000 total value - Your ownership and value remain the same [EXAMPLE] Apple did a 4-for-1 split in August 2020. If you owned 10 shares at $400, you received 40 shares at $100. Your $4,000 investment value didn't change—only the share count and price adjusted. ### Common Split Ratios - **2-for-1:** Most common, doubles shares, halves price - **3-for-1:** Triples shares, cuts price to one-third - **4-for-1:** Quadruples shares, cuts price to one-fourth - **3-for-2:** 50% increase in shares [KEY] Stock splits are cosmetic—they don't change company value. A $1,000 stock split 10-for-1 to $100 is no more "cheap" than before. Total value is what matters. ### Why Companies Split Stocks 1. **Accessibility:** Lower prices seem more affordable to retail investors 2. **Liquidity:** More shares trading can increase volume 3. **Psychology:** Investors perceive lower-priced stocks as having more upside 4. **Index inclusion:** Some indices prefer certain price ranges ### Reverse Stock Splits [DEFINITION] Reverse Split: The opposite of a split—consolidates shares to increase the price. In a 1-for-10 reverse split, 10 shares become 1 share at 10x the price. [WARNING] Reverse splits are often a red flag. Companies typically do them to: - Avoid delisting (exchanges require minimum prices) - Appear more "respectable" after major declines - Meet institutional investment requirements [EXAMPLE] A $2 stock does a 1-for-10 reverse split, now trading at $20. If you owned 100 shares ($200 total), you now own 10 shares ($200 total). The value didn't change, but often the downtrend continues. ### Trading Around Splits **Before a split:** - Announcement often causes positive sentiment - Some traders anticipate retail buying post-split - Stock may run up before the split date **After a split:** - Short-term: Sometimes continued enthusiasm - Long-term: Returns depend on fundamentals, not the split [TIP] Don't buy a stock just because it's splitting. The split itself creates no value. Buy stocks for their business fundamentals, not cosmetic changes. [EXERCISE] Tesla announces a 3-for-1 split. You own 15 shares at $900. After the split, what do you have, and is your position more valuable? |ANSWER| You have 45 shares at $300 each = $13,500 total. Before: 15 × $900 = $13,500. Your position value is identical—the split created no new value. ### Historical Context Famous splits: - **Apple:** 5 splits since going public (total 224-for-1) - **Amazon:** 20-for-1 in 2022, first split since 1999 - **Alphabet:** 20-for-1 in 2022 These high-profile splits often generate media attention but don't fundamentally change investment thesis.