As a trader, it’s important to familiarize yourself with different events that can affect a stock’s price: like stock splits . By educating yourself on what can influence share prices, you can be better positioned to spot trading opportunities and know how to act when you see them.
One event that can affect a stock’s price is a stock split. This happens when a company decides to multiply or condense the number of shares available.
While a stock split in and of itself doesn’t change the value of a company or its stock, it can create various opportunities for a trader. Here, I’ll introduce you to stock splits to help you better understand what they are and how to potentially trade them.
What Are Stock Splits?
A stock split occurs when a company alters the number of shares outstanding without changing the value of the shares.
The most common type of stock split is what’s called a forward split. This is when a company takes the shares outstanding and divides it into multiple shares. So one share might become three or five shares after the split. It could even be 20 shares.
Despite the fact that the number of shares increases, the total dollar amount remains the same. But the price of each share will be lower. So, the act of splitting the stock doesn’t change the company’s value.
Forward Stock Split Example
Let’s look at an example of a forward stock split. Say that Company X currently has 861.4 million shares outstanding. When the market closed, they had a per-share price of $592.33 and a market cap of about $510 billion.
Now the company’s announcing a 7-for-1 forward stock split. Let’s check out the numbers and what happens:
- 861.4 x 7 = This is the shares outstanding times the split number. There’ll be approximately 6 billion shares outstanding following the split.
- $592.33 / 7 = This is the per share price divided by 7. After the split, the new share price is $84.62.
- $84.62 x 6 billion shares = The market cap doesn’t change — it still adds up to approximately $510 billion. The value of the company hasn’t changed.
Why Perform a Forward Stock Split?
A company’s board of directors is responsible for choosing to perform a stock split. But why increase the number of shares if it won’t change the value of the company?
One reason is to keep the per-share price manageable. If a company’s share prices rocket to sky-high levels, a split can make buying shares more accessible to more buyers, like those with smaller accounts.
Reverse Stock Split
The reverse stock split is the opposite of a forward split, effectively consolidating the number of shares into a lower total count of shares outstanding. So, the reverse split increases share price while reducing the total number of shares.
And like a forward split, a reverse split doesn’t change the company’s value. The market cap and dollar amount of shares outstanding don’t change.
Why Perform a Reverse Stock Split?
A company will perform a reverse stock split to increase the per share price. But why?
One reason is that they might be below the minimum price to stay listed on a major exchange. They hope to circumvent dismissal by increasing the share price.
Or, if they’re currently not on a major exchange, the company might perform a revers split might with the hope of being uplisted.
Reverse Stock Split Example
Here’s an example of a reverse stock split. Say that Company Y currently has 30 million shares outstanding. When the market closed, they had a per-share price of $0.56 and a market cap of about $16.8 million.
Now the company’s announcing a 1-for-10 reverse stock split. Here’s what happens:
- 30 / 10 = This is the shares outstanding divided by the split number. There’ll be approximately 3 million shares outstanding following the split.
- $0.56 x 10 = This is the per share price multiplied by 10. After the split, the new share price is $5.60. If you previously held 100 shares of the stock, now you hold 10 shares.
- $5.60 x 3 million shares = The market cap doesn’t change — it still adds up to approximately $16.8 million.
How Can Stock Splits Affect Stock Price?
So if a stock split doesn’t affect the overall value of the company, how can it affect share price?
It’s really a matter of public perception.
In general, a forward split is seen as an optimistic move. It creates more liquidity and makes the per-share price more accessible to more buyers. So, the fact that a company performed a stock split can attract more buyers and raise the per share price following the split.
Reverse splits, on the other hand, tend to have a negative connotation. Why? Because frequently, poorly performing companies use a reverse split to reduce the risk of losing an exchange listing due to a very low cost per share.
That’s not always the case … Sometimes, a company performs a reverse split to gain more respect in the market or to gain a listing on a bigger exchange. But the perception of a reverse split is generally negative.
For example, recently the company Taronis Technologies performed a 1-for-20 reverse split. While shares were trading for less than 25 cents apiece, they were suddenly condensed into shares of over $4 each.
Unfortunately, the split wasn’t well received. By the next day, shares dropped to about $3. And within a month or so, they were less than $1. That just goes to show how little faith traders can have in reverse splits!
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What stock splits have you traded and how did it go? Leave a comment and tell me about your experience!