1. What is a stock split?
A stock split is a way for a company to reduce or increase the number of shares outstanding and make them more appealing to new investors. Splitting stock doesn't change a company's total value, it simply changes the number of outstanding shares. By reducing or increasing the number of outstanding shares, the company can in turn increase or decrease the share price to achieve the outcome it seeks.
2. How does a stock split work?
There are 2 types of stock splits: a forward split and a reverse split.
A forward split is when a company increases the number of outstanding shares held by current shareholders. Let's say you're a shareholder in Company X. You own 100 shares and each share is worth $50, for a total of $5,000. Company X decides to do a 2-for-1 forward stock split; this means you will now have 2 shares for every 1 that you own, or 200 shares, with each share now being worth $25. Although you now own twice as many shares, your investment in the company remains the same at $5,000.
A reverse split is when a company reduces the number of shares outstanding. For example, a 1-for-2 reverse stock split means that you'll receive one share for every 2 shares that you currently own. From the example above, you would end up with 50 shares each worth $100. Again, the total value of your holding remains the same.
3. Why would a company want to split its stock?
As the price per share of a company's outstanding stock rises, the pool of investors that are willing to invest becomes potentially smaller. In order to make the stock more affordable for investors (and increase liquidity), the company can perform a forward stock split, essentially lowering the price per share.
On the other hand, if a company's share price is too low, investors may take it as a warning sign. A company may want to perform a reverse stock split to increase its price per share to reassure investors of a company's value. This is often done out of necessity to meet a share price requirement and avoid being delisted from a stock exchange.
