Are stock splits good for investors? - SmartAsset (2024)

While onepilsA split does not change the value of your investment; it is generally a good sign for investors. In most cases, this means that the company is confident in its future position and wants to pursue further investments.

A stock split usually makes it easier for your investment to gain value, although this usually doesn't mean a sharp increase immediately.

What is a stock split?

A stock split occurs when a company changes the number of shares outstanding without changing its overall market capitalization. Stock splits come in two main categories:

Forward split

The vast majority ofstock splitsare forward cuts. In fact, this is almost always what someone is referring to when he or she generally speaks of a "stock split."

In a forward split, the company increases its shares in circulation. It splits each share into several new shares, multiplying the number of shares outstanding. Anyone who owns shares in the company will receive new shares based on their current investment. However, the stock price also divides by the same ratio, so the market value of the company and the value of a given investment remain the same.

Let's e.g. Let's say you own 10 shares of ABC Corp. It currently trades at $100 per share. share, giving you a total investment of $1,000 in the company. ABC Corp. decides to do a 4-1 stock split.

This means that ABC Corp. will issue four shares for each outstanding share before the split. The new stock price will be $25 per share (the original price of $100 divided by four), increasing ABC Corp.'s total market capitalization. is retained. For every share you owned before the split, you as an investor will receive four shares. This would give you 40 shares, each worth $25 per share.

Inverse distribution

A reverse split is relatively rare. In the event of a reverse split, the company consolidates the number of shares outstanding. In the same way as a forward split, the total market value of the company is preserved by changing the share price in proportion to the number of shares in issue. But here prices increase based on the split ratio.

For example, suppose ABC Corp. currently trading at $10. A 2-1 reverse split is announced. That means it will issue shareholders one share of stock for every two shares they owned before the reverse split. Each share will be worth $20 (the original stock price of $10 times two).

What happens to options?

The short answer is not much. After a stock splitstock prices are adjustedto keep the value of the total number of outstanding shares unchanged. It can cause the value of options on affected stocks to change dramatically. To prevent this, options (call or put) on shares that have been split are adjusted so that the split does not change the value of the options. The options contract adjustments are handled automatically by the options clearinghouse.

For example, if an investor has an option on 100 shares with a strike price of $10, after adjusting for a 2-for-11 split, the investor has two options. Each option represents 100 shares with a strike price of $5. The adjustment is made automatically byOpties Clearing Corporation(OCC), a derivatives clearinghouse. Investors don't have to do anything to keep the value of their options intact.

Reasons for a stock split

The main reason for a stock split is to adjust the company's stock price without changing its overall pricemarket valueor property. A company can lower its stock price by issuing new shares, but that would require selling more ownership in the underlying company. It can increase this stock price by buying back its own shares, removing ownership from the market. In both cases, however, this adjusts the market value and ownership shares of the company.

A stock split allows the company to change its stock price without changing its overall market value or the ratio of private to public ownership.

Forward stock splits occur when the company decides that its stock price has become too high. Often the company wants to lower the price to make more moneyinvestors. Higher stock prices can scare investors, so the company conducts a stock split to make its shares more available. This often leaves room for further, faster growth than the company would otherwise have achieved.

With a reverse stock split, the company may want to increase the perceived value of its shares. By consolidating shares, they increase their price per share. stock, which is often done to stabilize an overly volatile asset. By increasing stock prices, the company can slow down trading and make the stock price less exposed to small dollar fluctuations.

Are Stock Splits Good?

A stock split in itself is neither good nor bad. Even after the split itself, your position as an investor remains unchanged. You own a different number of shares, but the value of your investment remains the same.

However, stock splits often lead to portfolio growth.

With a forward split, the biggest advantage is that your shares can increase in value more quickly. New investors can buy in more easily, allowing for faster potential growth in the company's share price. That growth is also increased because you own more shares than before. Forward splits are also often associated with success, especially since most companies do this when business is going well.

Perhaps most importantly, it's easier for your shares to grow proportionately. For example, a $10 stock only needs to gain an additional $10 in value to double your investment, while a $100 stock needs ten times as much gain to achieve the same investor results. This can lead to much stronger portfolio growth, although the reverse is of course also true. A $10 stock only needs to lose $5 to halve the value of your investment.

Inverse distribution is more difficult. Companies often apply a reverse split to volatile or otherwise weak assets so that they do not correlate with strong performance as much as a forward split. However, a reverse split can do a lot to stabilize a volatile asset. Just as it is easier for a lower-priced stock to double or halve in value, a higher-priced stock has a much larger cushion against these types of low-dollar moves.

In short

Stock splits occur when a company changes the number of shares outstanding without changing their total value. Such divisions can be forward or backward. The former increases the number of shares an investor owns; the latter reduces the number of shares an investor owns.

The result is that each shareholder receives a new number of shares in proportion to their ownership in the company, and each share has a new price based on the company's market value.

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