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

If you’ve seen the financial news, you know that Amazon and Alphabet (Google) announced historic 20:1 stock splits. Other big-name companies, like Tesla, aren’t far behind them. With headlines this juicy, it’s easy for the media to sensationalize and bombard investors with speculations and predictions riddled with industry jargon. Today, we’ll clear the air and tell you what you need to know about this common practice. What is a stock split, and will it impact your portfolio? 

Understanding Stock Splits

A stock split is essentially exactly what it sounds like—a company splits its stock into multiple shares, with the most common being a 3:1 or 2:1 split. Let’s look at an example. Here’s how a hypothetical 3:1 stock split might play out. Imagine you own one share of Company XYZ. If Company XYZ were to split their stock 3:1, you would now own three shares instead of one. Cool, right? But just because you own more shares doesn’t mean you have an increased financial stake in the company. The total combined value of the shares in a stock split still equals the share’s initial value. In English, that means if one share traded at $75 and Company XYZ had a 3:1 split, you’d own three shares now, each worth $25.With a stock split, you own more shares, but the value remains the same. 

Why Do Companies Split Their Stock?

When a company decides to split its stock, some investors may think that the company’s viability is in trouble. But, as they’d say in a game of Hot and Cold, you’re getting colder. Here are some reasons why companies may consider splitting their stock. 

Improves Accessibility

Companies typically split their stock to lower the individual share price. Doing so makes trading more accessible to the average investor. Think about it—it’s easier to spend $25 per share than $75 per share. If the quoted market stock becomes too pricey, many companies will decide to split the stock. In many respects, it’s a safe practice since splitting doesn’t impact their market capitalization or shareholders’ value in the company. What it does do is make it easier for a larger number of people to invest in the company, and more investors can lead to more funding—a long-term win-win. Stock splits can also be valuable to those with equity compensation as you have more options and flexibility to diversify while still retaining some company stock. 

Increase Exposure

In addition to broader exposure on an individual level, splitting stock can have implications on a larger scale. The split may trigger eligibility for companies to be listed on the Dow Jones Industrial Index (Dow Jones), something Amazon likely has its eye on. How can companies earn their spot on this VIP list? The Dow Jones index is weighted by the share price. With a price-weighted index, a collection of stocks with similar share prices makes the overall index more balanced and accurate. Since Amazon’s share prices are currently over $3,000, they’ll likely remain off the list. However, lowering the price to roughly $150 per share (20:1 split) might make their case more enticing. When the Dow adds a company to its index, it drives additional demand because each fund (mutual fund, ETF, etc.) that tracks the Dow Jones index must purchase shares of that company.

The Unique Case Of Amazon And Alphabet (Google)

As mentioned, Amazon and Alphabet (Google) recently announced plans for 20:1 stock splits. This news was a major shock to many investors, as shares for these companies neared $3,000.Below (as of early April) would be the outcome of 20:1 stock splits for each company:

• Amazon - ticker symbol: AMZN

  • The current price per share: $3,366

  • Price per share after 20:1 stock split: $168

• Alphabet (Google) - ticker symbol: GOOG

  • The current price per share: $2,872

  • Price per share after 20:1 stock split: $143

You can quickly see how splitting the stocks will make shares more accessible to investors. By taking action, these companies increase their pool of shareholders and ultimately hope to boost the company’s funding long-term. There’s a little bit of psychology and behavioral finance at work with this strategy!In many ways, after a split, the stock becomes more enticing to retail investors that potentially would not feel as great if they only owned fractional shares of a company.

A Note On Fractional Shares

Sometimes stock splits can result in fractional shares, meaning that an investor holds less than the total value of one share. Don’t panic; this is quite ordinary with splits, mergers, and acquisitions.For example, if you owned less than 20 shares of Alphabet (or Google) via the GOOG ticker, you would likely have fractional shares after the 20:1 stock split takes place. You will still have the same total value of GOOG but will simply have less than one share.

What Stock Splits Mean For You And Your Financial Plan

Stock splits don’t mean much for shareholders. Yes, the quantity of shares you own changes, but the total value does not.Even if it doesn’t disrupt your portfolio, it’s still good to know that a stock split is happening because it could open up planning opportunities. For instance, say you were lowering your concentration risk by selling shares every quarter. After the split, you would want to adjust the number of shares you sell and the frequency of the sale. While obvious on the surface, it could be easy to miss if your finances are on autopilot. Building a comprehensive investment plan puts you in a strong position, regardless of whether you own stock in a company or are considering a split. Reach out today to better understand how a diversified portfolio can help you achieve your financial goals.