Share price growth can be a sign of success for a company, but too much can mean the stock becomes too pricey for new investors – it is at this point that a company may initiate a stock split.
This is when a company decides to increase the number of shares it has in issue by giving its current investors extra shares for each existing share that they already own.
Extra shares sound great on paper, but here is what it really means. We explain what a stock or share split is.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Why do companies use stock splits?
When a company launches a stock split, they issue more shares to existing investors.
This helps reduce their share price by spreading it across more shares, boosting liquidity and making the stock more affordable for new investors.
Major companies such as Amazon, Apple and Google-owner Alphabet have used stock splits in the past to bring their share price down.
How a stock split works
Shares are typically split by ratios of 2-for-1 or 3-for-1, meaning each stockholder will have two or three shares following the split.
Some companies have gone even higher. Alphabet completed a 20-for-1 split in July 2022.
As a result, the company’s share price will fall to reflect the larger number of shares in issue.
For example, if a company with 100 million shares at a share price of £5 per share, carries out a 2:1 (or two-for-one) split, the total number of shares increases to 200 million and the share price falls to £2.50.
This doesn’t reduce the market value of a company as the price is also split across all the shares.
So in the example above, the market capitalisation would stay at £500m and an investor who previously owned 100 shares worth £500 will now have 200 shares worth the same. All financial ratios such as earnings per share and dividends per share will be halved.
It is like cutting a pizza into 20 slices instead of 10, you still have the same amount but more pieces to share.
Shareholders aren’t really getting anything extra. Each investor still holds the same percentage of the company as they did before the split. It’s just that it’s divided into more individual shares.
Investors also retain the same voting rights but the main concern of a stock split is the type of investors it attracts.
Companies not faring so well may initiate a reverse stock split.
This is where the number of issued shares is reduced by a certain number, which in turn boosts the share price.
A reverse stock split is often seen as a desperate attempt by a company to artificially boost its value but it may help a firm remain listed or to attract the attention of other investors.
-
Why you should start investing earlyMost investors wish they had started earlier, and data shows that starting to invest sooner yields greater results over time
-
Rail fares could spike by 5.8% next year – how to save on train travelJuly’s RPI inflation reading tends to determine rail fare hikes in the following year. We look at how much your train tickets could cost, and how to save money
-
What's behind the big shift in Japanese government bonds?Rising long-term Japanese government bond yields point to growing nervousness about the future – and not just inflation
-
Halifax: House price slump continues as prices slide for the sixth consecutive monthUK house prices fell again in September as buyers returned, but the slowdown was not as fast as anticipated, latest Halifax data shows. Where are house prices falling the most?
-
Rents hit a record high - but is the opportunity for buy-to-let investors still strong?UK rent prices have hit a record high with the average hitting over £1,200 a month says Rightmove. Are there still opportunities in buy-to-let?
-
Pension savers turn to gold investmentsInvestors are racing to buy gold to protect their pensions from a stock market correction and high inflation, experts say
-
Where to find the best returns from student accommodationStudent accommodation can be a lucrative investment if you know where to look.
-
The world’s best bargain stocksSearching for bargain stocks with Alec Cutler of the Orbis Global Balanced Fund, who tells Andrew Van Sickle which sectors are being overlooked.
-
Revealed: the cheapest cities to own a home in BritainNew research reveals the cheapest cities to own a home, taking account of mortgage payments, utility bills and council tax
-
UK recession: How to protect your portfolioAs the UK recession is confirmed, we look at ways to protect your wealth.
