The Effects of Stock Splits

A stock split has very limited impacted on holder of the stock. It is simply a tool to reduce the per share cost of a stock in order to facilitate trade of the shares.

What is a stock split?

A stock split increases the number of shares in a company. It does not reduce the value of the investment made by existing shareholders, because it provides the shareholders with additional shares to make them whole.

For example, a 2 for 1 split of a stock with a price of $100 will cause the stock price to become $50. As part of the split, existing shareholders will have twice as many shares as they did prior to the split. This leaves the amount of their investment unchanged. Similarly, the dividend, if one exists, will be split so that the total income derived from the shares will be unchanged.

Why is it done?

The primary benefit of a stock split is derived by smaller investors. Historically, especially prior to online brokerage, it was less expensive to trade in even lots, such as blocks of 100 shares at a time. By keeping the price per share lower with splits, it was easier for small investors to trade the stock. There is far less reason to do this with the increased availability of flat fee brokers.

Companies that have shied away from splits

Some companies have been less inclined to use stock splits than others. The most extreme example is Berkshire Hathaway, which has never had a stock split and for which a single share can cost over $100,000. Another recent example is Google, which in its brief history has seen share prices over $500.

Reverse stock splits

Just as a "traditional" stock split can increase the number of shares held, a comany can elect to reduce the total number of shares with a reverse split. The logic is very much the same.

For example, a company that has a 1 for 2 reverse stock split with a starting price per share of $1 can reduce the number of shares and double the price per share. The dividend, if one exists, would also double. Like a traditional stock split, the investment of existing shareholders remains the same total amount.

Why are reverse stock splits declared?

Many stock exchanges have a minimum price per share requirement. This may be the most common reason for a reverse split. A company whose share price has dropped may find it necessary to prop up the price per share with a reverse split simply to remain on the stock exchange.