Stock Split

View FREE Lessons!

Definition of Stock Split:

A stock split occurs when a company exchanges its existing shares for new shares of stock without impacting the company’s capitalization or the value held by each shareholder. 

Detailed Explanation:

The most common stock split is a 2-for-1 split, meaning that a shareholder owning 100 shares valued at $50 per share before the split would own 200 shares valued at $25 per share after the split. Before the split, the shareholder's stock value equaled $5,000 (100 x $50) and after the split, the shareholder still owned stock valued at $5,000 (200 x $25). A stock split does not add any value to the holdings. A 3-for-1 stock split means the shareholder would receive three shares for every share owned before the stock split. 

A stock split does not change the company’s total capitalization, or market value. Suppose Zoey’s Bones has one million shares outstanding. Just prior to the split, each share was valued at $300. Zoey’s Bones would have a market capitalization of $300 million (1 million shares x $300 per share). The board of directors decides to have a 3-for-1 stock split. The number of outstanding shares would increase to three million, and the share price would adjust to $100. Zoey Bones would still have a market capitalization of $300 million (3 million shares x $100 per share).

Why would a company choose to split its stock if the market value does not change? A stock split increases the stock’s liquidity by increasing the number of shares outstanding. A company may feel a stock’s high price may prevent investors from investing in their company. For example, Tesla's common shares sold for over $1,500 in July 2020. Management believed the price discouraged employees and investors and chose to have a 5-for-1 stock split.

A stock split that increases the number of outstanding shares is a forward split. Occasionally companies will reduce the number of outstanding shares and increase the stock price by using a reverse stock split. Like forward splits, the total value a shareholder owns of a particular stock is unchanged and the company’s market capitalization is also unchanged. For example, an investor owning 200 shares valued at $10 per share would own 100 shares valued at $20 following a 1-for-2 reverse split. The value of the shareholder’s shares would be $2,000 before and after the reverse split. A company may exercise a reverse split if its shares fall sufficiently to jeopardize the stock’s listing on an exchange.

Dig Deeper With These Free Lessons:

Understanding a Stock's Performance Using Supply and Demand
Capital - Financing Business Growth 

Search the Glossary


Investment Calculator:

Market Overview:

Market quotes are powered by TradingView.com

Single Quote:

© 2018 Higher Rock Education and Learning, Inc. All rights reserved. No portion of this site may be copied or distributed by any means, including electronic distribution without the express written consent of Higher Rock Education and Learning, Inc.