The first obvious implication to remember is that while stock splits may generate short-term price movements, they do not change a company’s underlying value or an investor’s percentage ownership. In addition to a slight boost between the announcement and the split, researchers have generally found “post-split drift,” with “drift” being a term used for this and other events. This refers to how, after a significant corporate event (stock splits and other company announcements), there’s still an effect even though, all things being equal, there shouldn’t be.

This drift for forward stock splits means a slight bump in stock prices afterward. Despite these changes, the total value of an investor’s holdings remains constant. The decrease in the price per share precisely offsets the increase in the number of shares.

Other management decisions regarding its stock—such as changes to a dividend payment or a new stock offering—have implications for the company’s fundamentals, and thus, your investment value. Management of a company might decide to do a forward stock split if they believe the price is relatively “high” or that it is trading outside of an “optimal” range. This decision is made by management based on their subjective views of the historical trading range of the stock and other factors. Because a stock split doesn’t change the underlying value of your investment, you may not notice any more substantial changes than the number of shares in your investment account. A 2 for 1 stock split doubles the number of shares you own instantly.

Are Stock Splits Important with Widespread Fractional Share Investing?

It’s often compared with cutting a pizza into smaller slices—you have more pieces, but not more pizza. For example, a 1-for-3 reverse split is one that replaces every three shares owned by a company’s investors with a single share of stock. So, if you owned 30 shares of a company’s stock before such a reverse split went into effect, you’d own 10 shares afterward. It’s important to know that a reverse stock split generally (but not always) happens for a negative reason such as after a big decline in a stock’s price.

Active Investor

Here’s what you need to know about stock splits, how the process works, why it can have a positive or negative impact on a company’s market value, and other important details. Another way a share split can impact you as an investor is by making individual common shares more affordable. Following one of these events, you may be able to purchase shares of a stock that were previously unaffordable because their price was too high. Of course, this does not mean a stock will rise after a stock split announcement or when it goes into effect. Remember, a stock split in and of itself does not impact your holdings’ value.

Stock split examples

A stock split can make the shares seem more affordable, even though the underlying value of the company has not changed. A reverse stock split reduces a company’s number of shares outstanding. If you owned 10 shares of stock in a company, for example, and the board announced a 1-for-2 reverse stock split, you’d end up with five shares of stock. If the 10 shares were valued at $4 per share before the reverse split, the five shares would be valued at $8 per share after the reverse split. While a stock split doesn’t inherently change a company’s value, it can affect market perception and liquidity.

Whereas you owned one-eighth of the company before, as a result of the split you’ll now the stockholders equity section of the balance sheet own two-sixteenths. It doesn’t matter if you own a stock before or after a split because the value won’t change. A stock split is purely a mathematical decision that does not reflect the valuation of a company.

What are reverse stock splits?

Nevertheless, it’s important to grasp how stock splits work, especially for understanding how the market may react post-split. Stock splits can be good for investors because they make a stock’s price more affordable, allowing some investors who were priced out before to buy the stock now. For current holders, it’s good to hold more shares of a company but the value doesn’t change. The strength of a company’s stock comes from its earnings, not the price of its stock. When a company splits its shares, the value of the shares also splits. For example, suppose the shares of XYZ Corp. were trading at $20 at the time of the two-for-one split; after the split, the number of shares doubled, and the shares traded at $10 instead of $20.

This, in turn, can increase the value of the shares over the long run. The main purpose of a stock split is to reduce the price of an expensive stock — especially when compared with price levels of peers in the industry — making it accessible to more investors. If a stock costs less, it might be easier for an investor to incorporate it into their portfolio, especially if the shares were rather expensive before a share split. Since stock splits don’t add market value, much of it comes down to making the stock more attainable to everyday investors, and how this impacts behavior by influencing the psychology of investors. If you’re already a shareholder in a company when it declares a stock split, not much changes.

1. For instance, in a two-for-one split, an investor who owned one share priced at $100 would end up with two shares, each worth $50 but with the same total value.
2. The lower share prices resulting from a split may make the stock more accessible to smaller investors, potentially broadening the shareholder base.
3. The two shares have the same monetary value as the one share pre-split.

These company actions also tend to signal management’s confidence in future growth. After a split, the stock price will be reduced (because the number of shares outstanding has increased). Thus, while a stock split increases the number of outstanding shares and proportionally lowers the share price, the company’s market capitalization remains unchanged. For example, a common stock split ratio is a forward 2-1 split (i.e., 2 for 1), where a stockholder would receive 2 shares for every 1 share owned. This results in an increase in the total number of shares outstanding for the company, though no change in a shareholder’s proportional ownership.

This is important to keep in mind, as an investor may respond to such a split by thinking that their investment in a particular business is greater than it was before. There are nonrefundable several ways that a stock split can impact you as an individual shareholder. For existing shareholders, the result is the same — the total value of their shares remains consistent. Publicly traded companies have a set amount of outstanding shares available in the market.

Understanding stock splits

A reverse/forward stock split consists of a reverse stock split followed by a forward stock split. The reverse split reduces the overall number of shares a shareholder owns, causing some shareholders who hold less than the minimum required by the split to be cashed out. The forward stock split then increases the number of shares owned by the remaining shareholders. When companies opt for a stock split, they increase the overall number of outstanding shares and lower the value of each individual share. A split may reduce the price per share, but it doesn’t affect the company’s market capitalization. A company will typically announce a stock split several weeks before the split actually occurs.

A 3-for-1 stock split means that for every share an investor has, they will now have three shares. The combined value of those three shares would equal the value of what one share used to be. For example, if a stock was valued at $15 and there was a 3-for-1 split, each share would now be worth $5. In the case of a short investor, prior to the split, they owe 100 shares to the lender.