Stock splits are a common occurrence in the world of finance, yet many people are not familiar with their implications. In simple terms, stock splits occur when a company divides its existing shares into multiple shares. This can be done for various reasons, such as to make shares more affordable or to increase the liquidity of a company’s stock. In this article, we will explore the most common types of stock splits and their significance in the world of finance.
1. Forward Stock Split
A forward stock split is one of the most common types of stock splits, and it occurs when a company decides to increase the number of its shares. For example, if a company has 100 shares outstanding and decides to do a 2-for-1 split, it will double the number of shares to 200. This means that for every original share, investors will now have two shares. The value per share will also be halved. In this type of split, the total value of the shares remains the same, but the number of shares and their price changes.
Practical Example: In April 2014, Apple Inc. conducted a 7-for-1 forward split. This means that for every share an investor owned, they would receive six additional shares. For instance, if an investor owned 100 shares, they would now have 700 shares. This increased the affordability and liquidity of Apple’s stock, making it more attractive to investors.
2. Reverse Stock Split
A reverse stock split is the opposite of a forward split and is often done to increase the price of a company’s stock and make it more appealing to investors. In this type of split, the company reduces the number of shares while maintaining the same total value. For example, if a company has 10,000 shares outstanding and does a 1-for-10 reverse split, it will reduce the number of shares to 1,000 but increase the price by 10 times. This gives the impression that the company is more valuable and can attract investors who prefer to invest in higher-priced stocks.
Practical Example: In May 2018, General Electric (GE) did a 1-for-8 reverse split. This means that for every 8 shares an investor owned, they would receive 1 share. This reverse split was done to improve GE’s stock performance and make it more attractive to investors who prefer higher-priced stocks.
3. Split ratios
Another common type of stock split is the split ratio. This is usually represented in fractions, such as 2-for-3, 3-for-5, or 5-for-9. The split ratio determines the relationship between the old shares and the new shares after the split. For example, if a company does a 2-for-3 split, for every 3 old shares, an investor will receive 2 new shares. The split ratio can also be expressed as a percentage, such as 50% or 66.67%.
Practical Example: In September 2019, streaming giant Netflix did a 7-for-1 split. This means that for every share an investor owned, they received 6 additional shares, which amounts to a 700% split ratio.
4. Stock Dividend
A stock dividend is a type of split where a company distributes additional shares instead of cash dividends to its shareholders. This is usually done when a company wants to conserve cash. The stock dividend can be expressed in percentages or fractions, just like the split ratio.
Practical Example: In October 1999, Microsoft announced a 2-for-1 stock dividend, which meant that for every share an investor owned, they would receive an additional share. This was done instead of a cash dividend and was aimed at encouraging long-term shareholders to continue holding the stock.
In conclusion, stock splits are common in finance and can happen for various reasons. They can be a strategic move by a company to make its stock more attractive to investors, or to improve liquidity and affordability. Understanding the different types of stock splits and their implications can help investors make informed decisions and navigate the stock market with ease.