How Do Stock Splits Affect Shareholders?

Stock splits are declared by companies on their way up.

A stock split involves exchanging current shares for a larger amount. In a 2:1 stock split, current shareholders receive two shares for each share they currently own. At the time of the split the share value will also split. A 2:1 split will reduce the share price by half. The effects of a stock split are often initially more psychological than tangible.

Function

Stocks splits result in the shareholder owning more shares based on the ratio of the split. A 2:1 stock split leaves the shareholder with twice as many shares. A 3:1 triples the shares and a 3:2 gives the share holder three shares for every two owned. At the same time, the market price of the stock decreases in proportion to the stock split. The stock owner with 100 shares of a $30 stock will have 300 shares of a $10 stock after a 3:1 split. Stock splits do not affect the market or shareholder value in the stock when the split occurs.

Considerations

A board of directors usually elects to declare a stock split after the share price has risen significantly and the future prospects of the company are positive. Investors see a stock split as management and board belief in the future growth of the company. Also, a stock split brings down share prices so investors do not think the stock is overly expensive.

Significance

Some individual investors do not want to buy stock they think is too expensive. This can happen when the share price hits new highs or at a certain price level, like $100 per share. If you look at the overall stock market, few stocks trade for more than $100 per share. If a company's stock is at $120 and declares a 4:1 stock split the shares will be worth $30 per share after the split. Investors who will not buy a $120 stock may be more interested in the company at $30 per share.

Effects

Even though a stock split does not change the total value of the company's outstanding shares, a split can boost buying interest in the stock. A stock split is viewed as a positive event. Many companies that have provided long-term positive returns to shareholders have also declared regular stock splits to keep the share price in a range that is attractive to investors. At the extreme, very few investors want to buy shares that cost $1,000 or more. If company declares regular stock splits, the shareholder value can continue to grow without the share price becoming unattractively high.

Example

The stock of the Coca Cola Company is a great example of using stock splits over time. If an investor purchased one share of Coke stock in 1926, she would have 4,608 shares today, worth over $200,000 today. On a shorter time frame, 100 shares of Coca Cola purchased on Jan. 1, 1990 at about $10 per share would be worth 800 shares at a price of over $50 per share by the spring 2010.

References

• Investopedia: Understanding Stock Splits
• Accumulating Money: The Effects of a Stock Split
• Coca Cola: Stock Splits