Stock split

A stock split is a corporate event in which a company increases the number of its outstanding shares by issuing more shares to current shareholders. This process reduces the individual share price but keeps the company's overall market value unchanged. Stock splits are commonly used to make shares more accessible and attractive to individual investors.

Stock splits play a key role in the world of investing and corporate finance. In fact, some of the world's leading companies have executed stock splits multiple times over the years, making their shares more appealing and tradable. By adjusting the share price, companies aim to enhance liquidity while ensuring that ownership stakes remain proportional.

What is Stock Split?

A stock split is a procedure whereby a company divides its existing shares into a larger number of new shares. For example, during a 2-for-1 split, each shareholder receives one additional share for every share they already own, effectively doubling the number of shares while halving the price per share. The total value held by each investor does not change. Consider a scenario in which a company’s share price is £200, and an investor owns 10 shares. Following a 2-for-1 split, the investor will now own 20 shares, each worth £100, with the total value remaining at £2,000. Real-world examples include historical splits by major companies like Apple and Tesla, which have used this mechanism to keep shares within an approachable trading range for retail investors.

How Does a Stock Split Work?

A stock split typically involves a decision by a company's board of directors to increase the number of shares outstanding. The most common form is the 2-for-1 split, although splits can occur in different ratios like 3-for-2 or 3-for-1. After the split, the price per share adjusts in proportion to the increase in the number of shares, while the company’s total market capitalisation remains constant. The shares start trading at the new price on a specified date announced by the company.

For example, let’s assume a company with 5 million shares trading at £50 per share chooses to implement a 2-for-1 stock split:

Calculation:
- Pre-split shares: 5 million
- Pre-split share price: £50
- Market value: 5 million x £50 = £250 million

After the 2-for-1 split:
- Shares outstanding: 10 million
- Post-split price per share: £25
- Market value: 10 million x £25 = £250 million

The ownership, overall company value, and aggregate investment for each shareholder remain unchanged, but the number of shares and the share price are altered to increase affordability and liquidity.

Types and Variations of Stock Splits

Stock splits can occur in several forms. The regular stock split, such as 2-for-1 or 3-for-1, increases the number of shares. Conversely, a reverse stock split reduces the number of shares while increasing the price per share, frequently used to meet minimum price requirements for stocks to remain listed on major exchanges such as the London Stock Exchange or NASDAQ. Companies may choose the most appropriate method based on their specific strategic goals and market circumstances.

Impact on Investors and Dividend Payments

The main effect of a stock split is to make each share more affordable on the open stock market. This can help attract new, smaller investors. Following a split, dividend payments are typically recalculated according to the new share total. For example, if dividends amounted to £2 per share before a 2-for-1 split, after the split, each share would pay £1, but the total dividend payment to the shareholder remains unchanged.

Pros and Cons of Stock Splits

There are distinct advantages to implementing a stock split. One significant benefit is enhanced market liquidity; with more shares trading at a lower price point, it’s generally easier for investors to buy and sell. Lower share prices can also appeal to retail investors, potentially broadening the shareholder base. Additionally, a split can signify management’s confidence in company performance. However, stock splits do not impact the fundamental value of the company or its future cash flows. They may create the impression of increased value, but a split alone does not provide additional economic benefit. The administrative costs and potential confusion for some investors can also be drawbacks. Furthermore, academic studies and practical experience suggest that any perceived value from a split is often temporary, as the underlying value per share remains proportional after the split.

Historical Context and Common Use Cases

Stock splits have been used by corporate giants as far back as the early 20th century. As markets and share prices grow, companies often split their stock to keep prices accessible. Well-known examples include the periodic splits by technology firms and large consumer companies seeking to ensure regular investors are not priced out of owning a stake. Splits are more frequent during bull markets, when sustained price growth pushes shares to higher levels.

Important Considerations and Factors

Before a company initiates a stock split, factors such as market psychology, trading volume, historical performance, and regulatory guidelines are taken into account. It is also common for companies to make public announcements well in advance to prepare shareholders for upcoming changes. After a split, all outstanding shares, company options, and related equity instruments are readjusted to align with the new share structure.

Understanding how stock splits affect your investments can be an important part of building financial knowledge. For those exploring ways to support business growth or raise capital, learning about how share structure changes may impact future funding rounds is useful. If you are considering a stock split for your business or seeking advice on capitalisation options, detailed guidance is available through our business funding solutions to help you make informed decisions.