- THIS IS A COMMERCIAL COMMUNICATION- 

The how and why of stock splits

Written by Peter Siks | 5 minutes
TUE 08-09-2020

On August 28, two household names - Apple and Tesla - executed a stock split. What is a stock split and what does it mean for you as an investor?

In this article I explain the stock split phenomenon, explain why companies would want to split their shares and discuss the possible advantages and disadvantages of a stock split. I also consider a reverse stock split, the counterpart of the stock split. 

 

What is a stock split?

A stock split is nothing more than an adjustment of the nominal value of the shares. In a stock split, this means that the number of shares in a listed company increases without changing the market capitalization. If the par value is halved, the number of outstanding shares will increase by a factor of two. Nothing changes for the investor other than the fact that they receive more shares.

 

A (fictional) example:

Company ABC notes € 200 and will implement a 4-1 stock split. Mr Jansen owns 100 shares of ABC before the split. After the split, Mr. Jansen owns 400 ABC shares, which are now listed at € 50. The value has remained the same: € 20,000. The only change is the number of shares. Naturally, the administrative actions are carried out by Saxo Bank; you do not need to take any action.


Why are companies doing a stock split?

There are various reasons why companies implement a stock split. I will mention six of them:

  1. By decreasing the value of the share in absolute terms, it also becomes available to private investors with a smaller stock exchange.
  2. The number of shareholders may increase for the above reason. The share is therefore in the portfolio of more investors and thus the spread among investors is increased, which in turn benefits the trading volatility.
  3. Decrease the absolute value so that it is more in line with similar competing companies.
  4. Liquidity will increase due to the stock split. At first, for example, 2,000,000 shares were traded per day (at € 200 each), while after the split this will likely be 8 million shares. This benefits the spread (the difference between the bid and ask price).
  5. Doing an important 'Corporate Action' (which is a stock split) generates publicity. That in itself already has value.
  6. Additional is the psychological effect of a stock split. Things are going so well with (the stock market price of) a company that they 'have' to split up in order to remain attractive to investors. This could be interpreted as an implicit buying signal - issued by the management; In a number of cases, investors also hope for a dividend (increase) in the period after the stock split


The possible benefits of a stock split for you as an investor

In principle, nothing will change for you as an investor. You get more shares, but at a lower value. And apart from normal market fluctuations, the value before and after the split should be the same. Nevertheless, there are several of advantages:

  • As mentioned, liquidity is increasing. So, you can buy and sell with a smaller spread
  • The number of owners of the shares is also likely to increase and this could contribute positively to a more even price formation.
  • If you had the shares in position before the announcement of the split, there is a chance that they will have risen on the announcement of a split alone.


Are there any disadvantages of a stock split?

Actually, there aren’t any problems. The only thing where the administrative 'hassle' gives are options. In essence, nothing will change financially for the option holder either. What does change in existing series are the strike price and the contract size. For example: the call Apple with strike price 400 and contract size of 100, becomes the call 100 with a contract size of 400. The options investor, therefore, keeps the same number of options.


The reverse stock split

The opposite of the regular stock split is the reverse stock split. With a reverse stock split, fewer shares become available, which increases the price. Again, there are reasons why companies would want this.

  • here are enough investors who, on principle, do not invest in 'penny stuff'.
  • Some major stock exchanges require a minimum share value in order to be listed on that exchange. A reverse stock split increases that value;
  • A penny stock sometimes provokes speculative trading and a quotation at a more normal price level reduces this.
  • A company that is quoted on a few dimes contrasts sharply with competitors who have quotes of € 20, € 30 or € 40. A reverse stock split is an option to improve the image of the company.
  • Penny stocks are often not or hardly followed by analysts. An increase in the value of a share can improve this.
  • Many brokers provide little or no collateral on stocks below a certain amount. This makes it not interesting for some investors, because it cannot be invested with (collateralised credit) leverage.
  • It can also be a desperate attempt to give the price of a sliding share some shine.


Conclusion

Stock splits are a corporate action that in many cases is positive for the investor who owns these shares. For example, through higher liquidity and more even price formation. The value of the property does not essentially change, only the amount of shares increases. With a reverse split, the number of shares decreases and the price increases. Even now the value of the property does not change.


Investing comes with risks, your investment could decrease in value

Author

Peter Siks

With more than 30 years of experience, Peter Siks has now been tried and tested in investing. Among other things, Peter is interested in the psychological aspects of investing and since 2010 he has been working at BinckBank as an investor trainer.

The information in this article should not be interpreted as individual investment advice.  Although BinckBank compiles and maintains these pages from reliable sources, BinckBank cannot guarantee that the information is accurate, complete and up-to-date. Any information used from this article without prior verification or advice, is at your own risk.  We advise that you only invest in products that fit your knowledge and experience and do not invest in financial instruments where you do not understand the risks.

Related Articles

Agenda

Date Subject Place
21/10 Investing during bizarre times
Online 
All events & sign up