Stock Splits: What They Are, How They Affect Your Portfolio

Investors who already hold shares in the company don’t need to do anything or worry about splits happening. They’ll simply wake up on the day of the split to find their holdings adjusted accordingly. Reverse splits (turning more shares into fewer) often happen for slightly different reasons than typical splits. Many investors would struggle to come up with that much to invest with.

Reverse splits tend to go hand in hand with low-priced, high-risk stocks. This is especially true with reverse splits that result in a post-split share price that is many times the price of the stock’s current price. For example, let’s say you owned 10 shares of a stock trading at $100. In a 2-for-1 split, the company would give you two shares with a market-adjusted worth of $50 for every one share you own, leaving you with 20 shares.

• In February 2018, the insurance giant Aflac announced that it would do a 2-for-1 split effective March 16, 2018.
• But naturally, investors with more complicated positions in the stock—for instance, if they’re short-selling it or trading options—may wonder how the split affects those trades.
• Some opponents of stock splits view the action as having the potential to attract the wrong crowd of investors.
• A reverse split reduces a company’s outstanding shares increasing per-share value.

The company wanting to split their stock must pay a great deal to have no movement in its over market capitalization value. The likeliest reason Palo Alto Networks would find its shares under pressure is its valuation. During periods of economic uncertainty, investors gravitate to perceived-to-be “cheap” stocks. Based on Wall Street’s consensus earnings estimate, shares are trading at nearly 48 times forecast earnings for fiscal 2024 (Palo Alto’s fiscal 2024 ends on July 31, 2024). During periods of heightened uncertainty on Wall Street, it’s not uncommon for investors to seek safety in profitable, time-tested, outperforming businesses. While the “FAANG stocks” have been somewhat of a mainstay for investors over the past decade, it’s companies enacting splits that have been garnering plenty of attention over the past two years.

If we multiply the share price by the shares owned, we arrive at $15,000 as the total value of your shares. When an investor shorts a stock, they are borrowing the shares with the agreement that they will return them at some point in the future. For example, if an investor shorts 100 shares of XYZ Corp. at $25, they will be required to return 100 shares of XYZ to the lender at some point in the future. If the stock undergoes a two-for-one split before the shares are returned, it simply means that the number of shares in the market will double along with the number of shares that need to be returned. 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.

The Options Clearing Corporation will automatically make these adjustments for the sake of orderly and smooth functioning markets. On the other hand, investors usually perceive reverse splits as a negative. In many cases, companies undergoing reverse splits see share prices fall.

What is a Stock Split?

A reverse stock split is the opposite of a stock split (also known as a forward stock split). A reverse stock split occurs when a company consolidates the number of existing shares of stock into fewer higher-priced shares. Like with a forward stock split,  the market value of a company closing entries, sales, sales returns & allowances in accounting after a reverse split stays the same. Post-split, the share price was $135 (approximately $540 divided by 4). As a result, Apple’s outstanding shares grew from 3.4 billion to about 13.6 billion, while the market capitalization remained practically unchanged at $2 trillion.

• Market professionals have long debated the merits of splits and whether investors realize any benefit.
• Now, the company’s board of directors has decided to split the stock 2-for-1.
• With a reverse split, a company can potentially reduce the trading volatility of its shares by increasing the price or perhaps dampen speculative trading by making trades more expensive.
• Secondly, to attract big investors, as many institutional investors and mutual funds have policies against investing in stocks priced below a preset minimum per share.
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And there have been several examples of stocks that increase in value in the days and weeks following the initial drop following the split. Financial professionals and economic professors generally say stock splits are meaningless because the intrinsic value of the company does not change. The value of the investment is the same, the only thing that’s changed is the number of shares an investor owns.

Stock Split

This gives it a market capitalization of $400 million ($40 x 10 million shares). For each share shareholders currently own, they receive another share. They now have two shares for each one previously held, but the stock price is cut by 50%—from $40 to $20. Notice that the market cap stays the same, doubling the number of shares outstanding to 20 million while simultaneously reducing the stock price by 50% to $20 for a capitalization of $400 million.

Disadvantages of stock splits

Using this outdated approach, you’d buy a stock about two weeks before the announced date of a split, then sell it about two days ahead of the actual split. Stocks slated to split tended to rally into the split, then sell off after the split occurred. But, like many short-term trades or arbitrage opportunities, patterns changed. With this strategy, traders tended to create a self-fulfilling prophecy, but investors are savvier today than they were in the ’90s and early 2000s. They now realize the value of the stock isn’t changed through a split, so the excitement over splits just isn’t there.

The downturns of reverse stock split

In February 2018, the insurance giant Aflac announced that it would do a 2-for-1 split effective March 16, 2018. The company stated that it “enhances the liquidity of our shares” as the reason for the split. The “being made whole” calculation is relatively straightforward for options. Each option contract typically controls 100 shares of an underlying security at a predetermined strike price. The new share ownership is generated by taking the split ratio and multiplying by 100 while the new strike price is generated by taking the old strike price and dividing by the split ratio. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer.

While it’s always possible Palo Alto could sell off with the broader market and reach Tilton’s price target, this is a company whose tools and intangibles suggest it’s headed considerably higher. To begin with, Tesla kick-started a price war earlier this year that’s proving disastrous to its margins. The company’s four production models (S, 3, X, and Y) have endured more than a half-dozen price cuts. According to CEO Elon Musk, Tesla’s pricing strategy is entirely driven by demand.

If the company opts for a 2-for-1 stock split, the company would grant you an additional share, but each share would be valued at half the amount of the original. After the split, your two shares would be worth the same as the one share you started with. The results can be starkly different between owning a stock through a stock split and purchasing the stock after it splits. Ratios of 2-for-1, 3-for-1, and 3-for-2 splits are the most common, but any ratio is possible.

If a company’s stock price has gone up, the price may be too high for investors to purchase shares, and a stock split lowers the price of shares making them more attractive. A stock split means that existing shareholders receive additional shares, but the value of the shares will not increase due to the stock split. When a stock split is announced, an options contract undergoes an adjustment called “being made whole.” Existing shareholders were also given six additional shares for each share they owned prior to the stock split. So, an investor who owned 1,000 shares of AAPL before the stock split had 7,000 shares after the stock split. Apple’s outstanding shares increased from 861 million to 6 billion shares.

Another reason a company might opt for a reverse split is to make its stock look more appealing to investors who may regard higher-priced shares as more valuable. In the end, a stock split—or even a reverse stock split—doesn’t have a huge practical impact on a company’s current investors. A stock split’s biggest impact is on investors who might be watching a particular stock and hoping to purchase a full share for a lower price. For those investors, a stock split can provide a powerful motivator to get off the sidelines. Why do companies go through the hassle and expense of a stock split?