What Are Stock Splits And What Does It Mean For Your Investments?

If you’ve followed investing for any length of time, you’ve probably heard about companies splitting their stock. Stock splits often generate excitement in the media, sometimes accompanied by speculation and jargon-heavy commentary. Today, we’ll break down what a stock split is, why companies do it, and what it means for your portfolio.

Understanding Stock Splits

A stock split is exactly what it sounds like: a company splits its stock into multiple shares, with the most common ratios being 2:1 or 3:1. Here’s an example using a hypothetical company:

Imagine you own one share of Company XYZ. If Company XYZ implements a 3:1 stock split, you would now own three shares instead of one. The total combined value of the shares after the split remains equal to the initial value. So if one share was worth $75 before the split, each of your three shares would now be worth $25. With a stock split, you own more shares, but the total financial value remains unchanged.

Why Do Companies Split Their Stock?

Improves Accessibility

Companies typically split their stock to lower the individual share price. This makes investing more accessible to the average investor. For example, a share priced at $150 may feel out of reach to many, whereas splitting the stock so each share is $50 allows more people to participate. Stock splits do not impact a company’s overall market capitalization or the value shareholders hold, but they can broaden the investor base. Additionally, stock splits can benefit employees with equity compensation, providing more flexibility to diversify while retaining company stock.

Increase Exposure

Stock splits can also have larger-scale implications. For instance, some indexes are weighted by share price, and a lower share price could make a company eligible for inclusion. Inclusion in an index can drive demand because funds tracking the index must purchase shares of the company. More broadly, splits can appeal to retail investors, especially those who might be discouraged by high-priced shares.

A Note On Fractional Shares

Sometimes stock splits result in fractional shares, meaning an investor holds less than a full share. This is normal and occurs frequently in splits, mergers, and acquisitions. The total value of your holdings remains the same; you just may have a fractional share instead of a whole one.

What Stock Splits Mean For You And Your Financial Plan

Stock splits do not change the total value of investments for shareholders. However, knowing a split is happening can create planning opportunities. For instance, if you regularly sell shares to manage concentration risk, you would need to adjust the number of shares you sell and the timing after a split.

Even if you don’t own the stock undergoing a split, understanding the mechanics can help you recognize potential market effects and opportunities. Building a comprehensive investment plan puts you in a strong position, whether you own individual company stock or are considering purchasing shares that may split in the future.

Reach out today to better understand how a diversified portfolio can help you achieve your financial goals, regardless of stock splits or market activity.