How does a company decide when it is going to split its stock? (2024)

FAQs

How does a company decide when it is going to split its stock? ›

Stock splits are generally done when the stock price of a company has risen so high that it might become an impediment to new investors. Therefore, a split is often the result of growth or the prospects of future growth, and it's a positive signal.

Take Nvidia's 10-for-1 split, for example. A shareholder that holds a single share of Nvidia at $1,200 will now own 10 shares at $120 apiece. Either way, the position is worth $1,200. And there's no difference to the company's market valuation.

Owning shares before the record date ensures receiving the additional shares, which might provide a psychological boost in perceived value. However, waiting until after the split might provide an opportunity to buy at a lower price per share, potentially attracting more retail investors and driving further demand.

Of course, some of that outperformance may be because companies that tend to undergo splits usually do so only after a run of success where their stock prices have climbed strongly. And a stock split doesn't guarantee an ensuing rise in price.

As we have already mentioned, finance professors don't see any great impact of splits on a company's value or performance. A huge number of companies never split their shares because they believe that it is a symbol of a strong company to have a higher value of each share.

Although the number of outstanding shares increases and the price per share decreases, the market capitalization (and the value of the company) does not change. As a result, stock splits help make shares more affordable to smaller investors and provide greater marketability and liquidity in the market.

Are Stock Splits Good or Bad? Stock splits are generally done when the stock price of a company has risen so high that it might become an impediment to new investors. Therefore, a split is often the result of growth or the prospects of future growth, and it's a positive signal.

Stocks tend to significantly outperform the market in the 12 months after a split. A split improves the tradeability of a stock which reduces the company's cost of capital, positively affecting its fundamentals and pushing its valuation higher.

Normally, a stock split will reduce the price per share of each share in proportion to the increase in shares. Using this example, a 2-1 split for a stock trading at $200 would halve the price to $100 and double the number of total shares outstanding.

For shareholders, the total dollar value of their investment remains the same because the split doesn't add real value. The most common splits are two-for-one or three-for-one. A stockholder gets two or three shares respectively for every share held.

Who approves stock splits? ›

The Role of Regulators. As the Securities and Exchange Commission (SEC) explains, "state corporate law and a company's articles of incorporation and by-laws generally govern the company's ability to declare a reverse stock split and whether shareholder approval is required."

In stocks, a round lot is considered 100 shares or a larger number that can be evenly divided by 100. In bonds, a round lot is usually $100,000 worth. A round lot is often referred to as a normal trading unit and is contrasted with an odd lot.

Calculating total shares after stock split

Shareholders who wish to estimate the total number of shares that they will own after a stock split can use the following formula: Total number of shares post stock split = number of shares held * number of new shares issued for each existing share.

Chipotle's shares will begin trading on a post-split basis at the market open on Wednesday, June 26, 2024. "We believe the stock split will make our stock more accessible to our employees as well as a broader range of investors," said Jack Hartung, Chief Financial and Administrative Officer, Chipotle.

That said, many stocks have shown strong performance after a split. In other words, selling your shares of a stock prior to a split isn't always the best decision – unless, of course, you're not well-positioned to continue holding the stock.

Reverse stock splits do not impact a corporation's value, although they usually are a result of its stock having shed substantial value. The negative connotation associated with such an act is often self-defeating as the stock is subject to renewed selling pressure.

The number of shares owned after the reverse split can be calculated by the stated ratio of the stock split multiplied by the number of existing shares owned. For instance, a 1-for-10 reverse split ratio equals 10%, which can be thought of as exchanging ten $1.00 bills for a single $10.00 bill.

Say you have one share of a company's stock. If the company opts for a 2-for-1 stock split, the company would grant you an additional share, but each share would be valued at half the amount of the original. After the split, your two shares would be worth the same as the one share you started with.

Using Amazon's 20-for-1 stock split as an example, existing shareholders will get 20 shares for each share they currently own. When a company divides each existing share into 20 new shares, that also means that each share is now worth one twentieth of the original value.