In order to understand how stock splits affect stockholders, you must first know what they are. A stock split simply happens when the company issuing the stock decides to increase the number of shares in circulation while also lowering the price per share by dividing the value of each existing share between more shares. Stock splits do not affect the market value of your stock; instead, they allow investors to buy more shares without having to spend as much money on each one. To help you understand why stock splits occur and how they affect stockholders, we have compiled a brief guide below.
The Mechanics of a Stock Split
When a company splits its existing shares into multiple new shares, it usually happens when the stock price of the company is too high and the company wants to make it more affordable for investors. A stock split can also be a way to encourage more people to buy the stock, which can help the company’s equities. In general, a stock split is seen as a positive sign for the economy and inflation.
In a 2-for-1 stock split, for example, a company would increase its number of shares outstanding by 50% and then decrease its share price by 50%. If a company has 10 million shares at $100 per share, it will have 20 million shares at $50 per share after a 2-for-1 stock split. For example, Apple Inc. (AAPL) increased its stock price from $90 to $97 in October 2014 after announcing a 7-for-1 stock split effective on June 9th 2015. The company also boosted its authorized share capital by 1 billion shares to make room for additional future issuances.
The History Behind Stock Splits
When the board of directors of a company decides to issue additional shares to its existing shareholders, a stock split takes place. The goal is usually to make the shares more affordable and therefore attractive to a wider range of investors. Stock splits have been around for over a century, and they’ve been used as a tool to try and boost the economy during periods of inflation. More recently, stock splits have become less common as the stock market has become more accessible to a wider range of investors.
Over time, stock splits have become less common as a way for companies to help boost their shares’ value. Today, it’s more likely that if a company does decide to split its shares, it will use another strategy for attracting investors—one of which is raising dividends. Dividends are monetary distributions made by a company’s board of directors to its shareholders on a periodic basis. The company can raise them whenever it wants and doesn’t have to hold a stock split in order to increase them. Over time, stock splits have become less common as a way for companies to help boost their shares’ value. Today, it’s more likely that if a company does decide to split its shares, it will use another strategy for attracting investors—one of which is raising dividends.
How Do Stock Splits Affect Short Sellers?
As a result of a split, there are some changes that occur that can affect the short position, but not significantly. Nevertheless, they do not affect the value of the short position. Number of shorted shares and price per share are two of the biggest changes in the portfolio. In shorting a stock, an investor borrows the shares and agrees to return them at a later date. As an example, if an investor shorts 100 shares of XYZ Corp. at $25, they will need to return 100 shares of XYZ to the lender at some point in the future. If the stock is split two-for-one before the shares are returned, then both the number of shares and the number of shares that must be returned will double.
The value of a company’s shares is also divided in half if they divide their shares in half. For example, suppose XYZ Corp. shares have been trading at $20 a share, but their shares get split, and their value has now been halved. as a result of the split, an investor with 100 shares at $20 for a total of $2,000 now has 200 shares at $10 for a total of $2,000. A small shareholder owes the lender 100 shares before the split. After the split, they will owe the lender 200 (that are worth less) shares. After the split, if an investor holds a short position in the market, he or she will buy 200 shares for $10 and return them to the lender.
A short investor makes a profit of $500 (money received at the short sale: $25 x 100) minus the cost of closing out the short position ($10 x 200). That is, $2,500 – $2,000 = $500. It was entered for a short of 100 shares at $25, which is equivalent to 200 shares at $12.50. So the short made $2.50 per share on the 200 shares borrowed, or $5 per share if sold before the split.
Reasons Why Companies Announce Stock Splits
When a company’s share price reaches a level that makes some investors uncomfortable, or surpasses the share prices of comparable companies in the same sector, the company’s board may choose to implement a stock split. The stock split may make the stock seem more affordable, even though the company’s value hasn’t changed. It may also increase the liquidity of the stock.
When a stock splits, the share price can go up—despite a small drop immediately after the split. This is because small investors might see the stock as more affordable and buy more of it. this strengthens demand for the stock and drives up prices. Alternatively, a stock split may signal to the market that the company’s share price has been increasing; many investors believe this steady growth will continue in the future, leading to continued rise in prices.
Next Steps after a Stock Split
A stock split is when a company divides its existing shares into multiple new shares to boost liquidity and make the stock more affordable. Stock splits don’t necessarily mean that the company is doing well, but they can be a good sign that management is confident about the future. After a stock split, shareholders will own more shares, but each share will be worth less. This doesn’t change the value of your investment, but it can affect how you trade your equities. If you’re planning on selling soon, you may want to wait until after the stock split so you can sell more shares. If you’re a long-term investor, stock splits shouldn’t have much of an effect on your strategy.
If you’re a long-term investor and want to keep your stock exposure constant, don’t do anything right after a stock split. You’ll still have all of your shares when it’s time to sell them, but they’ll be worth less due to the split. A great way to avoid dealing with these fluctuations is simply not making any trades in stocks that you intend to hold onto for a long time. If you already own stocks prior to a split and plan on keeping them for months or years, it may make sense to wait until after a stock splits before selling them. This helps smooth out some of those fluctuations if they occur while you own those stocks.