Business, Legal & Accounting Glossary
A stock split occurs when a company releases additional stock in a structured manner without decreasing shareholder equity. For example, in a 2 for 1 stock split, an investor who owns 100 shares of a stock valued at $100 per share before the stock split will own 200 shares valued at $50 per share after the split. After the stock split the investor owns twice as many shares, with each share worth exactly half as much as before the stock split. While a 2 for 1 stock split is probably the most common form of stock split it is not the only form. 3 for 1 stock splits and other ratios of stock splits are also possible.
In the majority of cases, the purpose of a stock split is to reduce the share price of a stock in order to make the stock more affordable to a wider pool of investors.
A stock split is a type of corporate action that replaces shares in a public company with more shares in the same company at a lower price. Although this leaves the market capitalization of the company the same, an increase in the number of shares leads to greater liquidity, and therefore a greater volume of trades. This often leads to a higher stock price in the short term. The lower price per share also makes the company more accessible to some smaller investors.
For example, a company with 100,000,000 shares outstanding and a stock price of $50 per share has a market capitalization of $5,000,000,000. If the company initiated a 2-for-1 stock split, every investor in the company would be given 2 shares at $25 for every 1 share at $50. Then the company would have 200,000,000 shares outstanding with a price of $25 per share, so the market capitalization remains $5,000,000,000. 2-for-1 splits are the most common, but others include 3-1, 3-2, 4-3, 5-2, and 5-4.
The reverse stock split, or consolidation, is not as common. It can be used by a company to drive up the raw price of the shares while leaving the valuation the same. This is mostly used when a company’s share price drops into the pennies, which makes it disappear from many financial companies’ radar. Reverse splits are generally frowned upon by investors as last-ditch efforts by company management to avoid delistment from stock exchanges and as a means of making a struggling company appear more valuable without actually changing anything.
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This glossary post was last updated: 20th February, 2020