What is a Stock Split?

Published by Thomas Herold in Investments, Trading

'Stock Split' is explained in detail and with examples in the Trading edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Stock splits occur when corporations decide to expand the number of underlying shares in the company. They do this by setting out a ratio for the stock split. They might say that for every one share of stock, there will now be two, which would double your existing shares. This would be called a two to one stock split.

If you had one hundred shares of the stock before the split that were trading at twenty dollars per share, then you would possess fifty shares of the stock trading at ten dollars each share after the split occurred. The value of the total shares owned does not change as a result of a stock split, only the amounts of shares that you possess and the per share price of the stock in question. In either case, they would still be worth two thousand dollars.

Companies mostly engage in stock splits because of a liquidity motivation. There are many companies that feel that more expensive stocks keep investors from buying them. By splitting the shares, the price of the shares declines proportionally. They hope that this will result in a scenario where greater quantities of shares of the stock are then purchased and sold. The downside to this argument is that the higher volume of the shares traded could cause larger drops and increases in the price of the stock, which leads to greater volatility in the share prices.

While numerous investors believe that stock splits are beneficial, there is no real evidence to support this feeling. Stocks do not automatically rise back to the price that they maintained in advance of the split. The extra shares do not result in greater amounts of dividends being realized by the investors either, since each share then represents proportionally smaller earnings, assets, and dividends of the company involved in the split.

While most companies go through stock splits as the price rises, a select few have steadfastly refused to do so. Berkshire Hathaway proves to be the most famous case of this. In the 1960’s, it traded at only $8 each share. In recent decades, you have seen its value jump up to $150,000 per share. The Washington Post has also seen its non splitting shares trade upwards of six hundred dollars each. The shareholder base of both companies has remained consistent and stable as a result of not splitting the stock shares.

Free Download (No Signup Required) - The 100 Most Important Financial Terms You Should Know!
This practical financial dictionary helps you understand and comprehend the 100 most important financial terms.

The term 'Stock Split' is included in the Trading edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.