Stock splits & dividends

If a company thinks its stock price is too expensive or too cheap, it can consider a stock split. There are two types of stock splits: forward and reverse.

• Forward stock splits increase the number of outstanding shares.
• Reverse stock splits decrease the number of outstanding shares.

Forward stock splits

Forward stock splits are used when a company believes its stock price is too expensive for the average investor. Suppose ABC Company’s stock price has risen to $500 per share, which is relatively expensive (many stocks trade between $30-$150). ABC Company could lower its price per share through a forward stock split.

A forward split increases the number of shares each stockholder owns, and the stock price decreases proportionately. The total value of the position stays the same.

Let’s work through a few examples.

A stockholder owns 100 shares of ABC Company at a current market price of $500 per share. How will a 4:1 forward stock split impact shareholders?

Each stockholder receives four shares for every one share owned.

To find the stock split factor, divide the first number by the second number

$\text{SS factor}=\frac{\text{first SS number}}{\text{second SS number}}$

$\text{SS factor}=\frac{\text{4}}{\text{1}}$

$\text{SS factor}=4$

To find the number of shares adjustment, multiply the original number of shares by the stock split factor

$\text{New shares}=\text{old shares x SS factor}$

$\text{New shares}=\text{100 x 4}$

$\text{New shares}=\text{400}$

To find the price per share adjustment, divide the original price per share by the stock split factor

$\text{New price}=\frac{\text{old price}}{\text{SS factor}}$

$\text{New price}=\frac{\text{\$500}}{\text{4}}$

$\text{New price}=\$125$

Put it all together and compare before and after to confirm

$\text{Before the split:}$

• 100 shares @ $500 = $50,000

$\text{After the split:}$

• 400 shares @ $125 = $50,000

To build confidence with stock split calculations, take a look at the real-world story of Apple’s 7:1 stock split in 2014:

Now try one on your own.

A stockholder owns 300 shares at a current market price of $90 per share. The issuer performs a 3:2 stock split. What adjustment is made to the investor’s position?

What is the stock factor?

How many shares will the stockholder end up with?

What is the new price per share?

Summarize the final result.

In each example, the stockholder ends with the same overall value ($27,000 in the last example). Only the number of shares and the price per share change.

A helpful analogy is slicing a pie. If you cut one pie into two pieces, you now have two pieces instead of one - but you don’t have more pie overall.

Sidenote

Even vs. uneven stock splits

Stock splits can be considered even or uneven depending on the setup.

An even stock split is any stock split that ends in the number ‘1.’ Here are some examples of even stock splits:

• 2:1 stock split
• 4:1 stock split
• 7:1 stock split

If a stock split ends in any number other than 1, it’s considered uneven. Here are some examples of uneven stock splits:

• 3:2 stock split
• 5:4 stock split
• 7:2 stock split

Reverse stock splits

Reverse stock splits are used when a company believes its stock price is too low (the opposite of forward splits). Instead of waiting for market demand to raise the stock price, a company can do a reverse stock split to increase the price per share immediately.

Let’s go through a reverse split example together.

An investor owns 100 shares of stock at a current market price of $10. How will a 1:5 reverse stock split impact the position?

Each stockholder receives one share for every five shares owned.

To find the stock split factor, divide the first number by the second number

$\text{SS factor}=\frac{\text{first SS number}}{\text{second SS number}}$

$\text{SS factor}=\frac{\text{1}}{\text{5}}$

$\text{SS factor}=0.2$

To find the number of shares adjustment, multiply the original number of shares by the stock split factor

$\text{New shares}=\text{old shares x SS factor}$

$\text{New shares}=\text{100 x 0.2}$

$\text{New shares}=\text{20}$

To find the price per share adjustment, divide the original price per share by the stock split factor

$\text{New price}=\frac{\text{old price}}{\text{SS factor}}$

$\text{New price}=\frac{\text{\$10}}{\text{0.2}}$

$\text{New price}=\$50$

Put it all together and compare before and after to confirm

$\text{Before the split:}$

• 100 shares @ $10 = $1,000

$\text{After the split:}$

• 20 shares @ $50 = $1,000

Before you work through an example on your own, here’s a real-world example: Citigroup’s reverse stock split in 2011.

Try one on your own now.

A stockholder owns 400 shares at a current market price of $20 per share. The issuer performs a 4:5 reverse stock split. What will the investor’s stock position become?

What is the stock factor?

How many shares will the stockholder end up with?

What is the new price per share?

Summarize the final result.

As in the forward split examples, the stockholder ends with the same overall value ($8,000 in the last example) after the split.

Stock splits (forward and reverse) affect all stockholders, so there is no change in proportionate ownership. If an investor owns 25% of the outstanding shares before a stock split, they’ll still own 25% after the split.

Using the pie analogy again: imagine you and three friends split a pie into fourths, so each person has a 25% stake. If you cut your slice in half (similar to a 2:1 forward stock split), you have more slices, but each slice is smaller. You still own 25% of the overall pie.

To summarize, stock splits do not change overall investment value. They do change:

• the price per share
• the number of shares outstanding

Although stock splits are relatively insignificant in the long run, they require approval* from stockholders.

*Stock splits (forward and reverse) affect a common stock’s par value. While par value on common stock is a relatively unimportant accounting measure, actions impacting par value generally require shareholder approval.

Stock dividends

Stock dividends are another way to receive additional shares. Like stock splits, stock dividends are a reshuffling of numbers that can influence the stock price.

If a company pays a stock dividend of 25%, each investor ends up with 25% more shares, and each share falls proportionately in price. The overall value of the position stays the same.

If you understand the math behind stock splits, stock dividend math will feel very similar. Here’s an example.

An investor owns 100 shares of stock at $20/share. The investor receives a 25% stock dividend. What changes?

Let’s go through the math. The first step is to find the stock dividend factor.

To find the stock dividend factor, add the stock dividend percent (in decimal form) to 1

$\text{SD factor}=\text{SD (decimal form) + 1}$

$\text{SD factor}=\text{0.25 + 1}$

$\text{SD factor}=\text{1.25}$

To find the number of shares adjustment, multiply the original number of shares by the stock split factor

$\text{New shares}=\text{old shares x SD factor}$

$\text{New shares}=\text{100 x 1.25}$

$\text{New shares}=\text{125}$

To find the price per share adjustment, divide the original price per share by the stock dividend factor

$\text{New price}=\frac{\text{old price}}{\text{SD factor}}$

$\text{New price}=\frac{\text{\$20}}{\text{1.25}}$

$\text{New price}=\$16$

Put it all together and compare before and after to confirm

$\text{Before the split:}$

• 100 shares @ $20 = $2,000

$\text{After the split:}$

• 125 shares @ $16 = $2,000

As you can see, the investor ends with the same overall value they started with ($2,000). Comparing the before-and-after totals is a good way to confirm your work.

Now try a stock dividend scenario on your own.

An investor owns 300 shares of JPM stock @ $115. They receive a 15% stock dividend. What changes?

In conclusion, stock splits and stock dividends change the number of outstanding shares but don’t cause shareholders to gain or lose overall value. Both can move the price per share up or down, but there are differences.

The most important difference here is voting:

• Stock splits require shareholder approval.
• Stock dividends do not (similar to cash dividends).

With the consent of the Board of Directors, a stock dividend can occur whether the stockholders want it or not.

Key points

Forward stock splits result in:

• More shares outstanding
• Lower price per share
• Same overall value

Reverse stock splits result in:

• Fewer shares outstanding
• Higher price per share
• Same overall value

Stock dividend consequences

• More shares outstanding
• Lower price per share
• Same overall value

Stockholder approval (voting)

• Stock splits require approval
• Stock dividends do not require approval