Like an oversized piece of cake, a stock with an expensive price tag can be tough for investors to swallow. While fractional shares help to some extent, high-priced stocks often face psychological barriers. To address this, many companies pursue stock splits.
What Are Stock Splits?
A stock split occurs when a company issues additional shares to its existing shareholders, which proportionately reduces the company’s share price. Companies usually announce an upcoming stock split along with its effective date. Once a split takes place, shareholder accounts will reflect the new share count and price adjustment.
For example, let’s assume you own 100 shares of a stock that’s worth $500 per share; if the company declares a 2-for-1 stock split, your share count would double to 200 shares while the share price would halve to $250 per share. The total value of your holdings remains $50,000.
The most common stock splits are 2-for-1, 3-for-2, and 3-for-1. Occasionally though, highly priced stocks undergo larger splits, such as Chipotle’s notable 50:1 split in June 2024, one of the biggest on record.
Stock splits aren’t reserved for mega-cap enterprises or elevated stock prices though — smaller public companies and reasonably priced firms can also enact stock splits. For example, Mueller Industries, a small cap stock at the time, executed a 2:1 split in September 2023, as shares adjusted from $70.14 to $35.07.
Why Companies Do Stock Splits
Stock splits are essentially a way to make shares more affordable and accessible to a broader range of investors without altering the underlying value of the company. Although a stock split doesn’t impact the company’s overall worth, it can positively influence investor perception. Lower entry points can galvanize investors to buy shares, boosting share price, market capitalization, and liquidity.
Alternatively, companies may pursue stock splits in hopes of inclusion in price-weighted funds or indexes. Amazon, for example, completed a 20:1 stock split in June 2022 — shares closed at $2,495.80 and promptly adjusted to $124.79 to account for the split. This ultimately paved the way for Amazon to be included in the Dow Jones Industrial Average (DJIA), which is a price-weighted index.
Types of Stock Splits
There are two common types of stock splits: forward and reverse. While neither impacts the underlying value of the firm, both types are viewed quite differently.
Forward stock splits
Forward stock split is another name for a traditional stock split, by which a company issues additional shares to current shareholders. This can be effected through various methods, such as an amendment to the company’s incorporation documents or a 100% stock dividend.
Companies often use forward stock splits to bolster liquidity and potentially facilitate new demand thanks to a lower, more palatable share price.
Reverse stock splits
Companies can also choose to go the other direction and consolidate existing shares, thereby raising their share price proportionally. For example, if a stock trades at $4 per share and the company declares a 1-for-10 reverse split, the stock will adjust to $40 and shareholders will see their position divided by 10.
Companies may use reverse splits to inflate their stock prices and avoid delisting from stock exchanges, as many have minimum pricing requirements. For instance, if a company listed on the New York Stock Exchange falls beneath $1 per share for 30 consecutive days, it has 6 months to recover, or else it risks being delisted.
Historical Examples of Stock Splits
Several high-profile companies have executed stock splits that garnered significant investor attention. For instance, Amazon announced its 20:1 split after markets closed on March 9, 2022; on the following day, shares of AMZN rose 5.4% and trading volume spiked over 63%.
Even though renewed investor interest usually fades over time, successful stocks can return to their pre-split highs. After a 4:1 stock split in 2021, Nvidia shares adjusted from $744.40 to $186.10. Strong performance and fervent investor demand over the ensuing years pushed its share price well beyond this mark and up to $1,217.90, before a 10:1 stock split in June 2024.
There have been plenty of notable reverse stock splits as well. For example, after severe price deterioration, WeWork announced a 1-for-40 reverse split in August 2023 — it was a last-ditch attempt to stabilize its share price and avoid delisting. Shares fell more than 11% that day, and WeWork would eventually file for bankruptcy about two months later.
While reverse stock splits tend to have a negative connotation, they aren’t always a sign of impending demise. A notable instance is Citigroup’s 1-for-10 reverse split in 2011. The financial company’s shares had sagged below $5, an unofficial price cutoff for mutual funds. To improve perception and facilitate investor interest, Citigroup announced the reverse split as well as a nominal dividend. While the move wasn’t well-received initially, the share price eventually stabilized and the company has continued operating.
Are Stock Splits Good or Bad?
Stock splits are fundamentally neutral events. Issuing or consolidating shares does not create value out of thin air — if anything, processing a split can incur expenses and hit a company’s bottom line (albeit marginally in most cases). However, depending on the circumstances surrounding the stock split, market reactions can vary.
Forward splits are typically seen as a positive event. Oftentimes, they stem from a period of price appreciation and signal management’s confidence in the company’s future growth. Moreover, by lowering prices, stock splits make shares more affordable, possibly influencing investors psychologically and spurring demand.
On the other hand, reverse splits can be perceived negatively and may indicate underlying issues. There could be a variety of catalysts driving shares down — declining revenue, operational problems, industry challenges, or general economic turmoil. Whatever the reason, investors should analyze the broader context of any stock split. That said, simply because a company chooses to reverse split its stock doesn’t guarantee that its share price will flounder.
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