Stock splits

Stock splits are used by issuers that believe their stock price is either too high or too low. Two types of stock splits exist:

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

Forward stock splits

Issuers enact forward stock splits when they believe their stock price is too expensive for the average investor. Suppose ABC Company’s stock price rises to $300 per share, which is relatively costly (most stocks trade between $30 - $150). The company typically doesn’t want the stock to lose market value just to make the price per share look lower. Instead, it can reduce the price per share without changing the total market value by using a stock split.

A forward stock split increases the number of shares a stockholder owns, and the stock price decreases proportionately. Let’s work through an example.

A stockholder owns 100 shares of ABC Company at a current market price of $300 per share. How will a 2:1 forward stock split impact shareholders?

Each stockholder receives 2 shares for every 1 share owned.

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

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

$\text{SS factor}=\frac{\text{2}}{\text{1}}$

$\text{SS factor}=2$

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

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

$\text{New shares}=\text{100 x 2}$

$\text{New shares}=\text{200}$

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

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

$\text{New price}=\frac{\text{\$300}}{\text{2}}$

$\text{New price}=\$150$

Put it all together and compare before and after to confirm

$\text{Before the split:}$

• 100 shares @ $300 = $30,000

$\text{After the split:}$

• 200 shares @ $150 = $30,000

A stock split doesn’t change the overall value of the investor’s position. In this example, the investor starts with $30,000 of stock and ends with $30,000 of stock. What changes is the share count (up) and the price per share (down).

To build confidence with stock split calculations, here’s 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 split factor?

How many shares will the stockholder end up with?

What is the new price per share?

Summarize the final result.

Reverse stock splits

Issuers enact reverse stock splits when they believe their stock price is too cheap. Rather than waiting for market demand to push the price higher, an issuer can use a reverse stock split to increase the price per share immediately.

Let’s go through an example.

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 1 share for every 5 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 the real-world story of 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 split factor?

How many shares will the stockholder end up with?

What is the new price per share?

Summarize the final result.

As these examples show, the stockholder ends up with the same overall value (for example, $8,000 in the last problem) after a stock 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 in a company before a stock split, they’ll still own 25% after the split.

Here’s a helpful analogy: imagine you and three friends slice a pizza into fourths, so each person has a 25% stake. Cutting your slice in half is similar to a 2:1 forward stock split. You now have more slices, but each slice is smaller. Either way, you still own 25% of the pizza.

To summarize, stock splits do not affect overall investment value. However, the price per share and the number of shares will change. Although stock splits are fairly insignificant in the long run, they do require approval* from stockholders.

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

Key points

Stock splits

• Legal method for issuers to manipulate stock prices
• Shareholders maintain the same proportionate ownership
• Require shareholder approval

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