Stocks Splits, What really happens and why?

  • 2022-04-20 08:24:42
  • 5 min read

Stock splits take place when companies increase the number of shares and decrease the value of each one. A company may split its stock when the market price per share is so high that it may prevent small investors from buying the shares. They are usually initiated after a large run-up in the share price. A stock split causes a decrease in the market price of individual shares but does not change the total market capitalization of the company.

For example, after a 10-for-1 split, each investor will own 10 shares for every one share he holds. A recent example is when Amazon announced its board of directors approved a 20-for-1 stock split for the first time since 1999. This means that the cost of Amazon’s share price, almost $2,800 per share, would be significantly cheaper to buy, and current shareholders would get 19 additional shares for each one they own. Following this news, Amazon’s stock soared more than 6% in after-market trading, the company also announced that it’s authorized to buy back up to $10 billion worth of shares.

Another example, took place in August 2020, when Apple did a 4-for-1 split, meaning each share of the company’s stock was broken into four new shares. Shares went from costing $499.23 per share to just $124.81.

A stock split is often a sign that a company is thriving and while that’s a good thing, many companies may do a stock split to make the stock more affordable and attractive to most types of investors.

While splits can increase a stock’s liquidity and make it more accessible, not all companies engage in them.  The most renowned example of a company avoiding a stock split is Warren Buffet’s company, Berkshire Hathaway. The company has never split its Class A stock, which closed recently above $500,000, a share. This helped push the company’s market cap above $730 billion making it the number 6 most valuable company in the U.S. When asked about the reason behind avoiding a stock split, Buffet said:” We want to attract shareholders who are as investment-oriented as we can possibly obtain, with as long-term horizons”. If Berkshire were to split the stock and lower its price, “we would get a shareholder base that would not have the level of sophistication and the synchronization of objectives with us that we have now”.

Bank of America announced that it expects more stock splits from US companies, in the near future. This is because S&P 500 stocks with a share price of $500 or more have a total market value of over $ 6 trillion, which is about 17% of S&P 500’s total value. With popular trading platforms such as Robinhood Market (HOOD) and TD Ameritrade, it is believed that lowering absolute stock prices could have a big impact on increasing investor interest.

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