Stock Splits
Of all the things to worry about regarding one's investment, stock splits are not one of them. Stock splits are entirely harmless to one's ownership in stock and have no impact on your position from a fundamental standpoint. However, it is still valuable to understand what a stock split is and why businesses undertake these activities.
Stock splits are an increasingly less common occurrence in financial markets. However, stock splits still occur and may be confusing as new investors see changes to the number of shares they own and the price of a stock that announces a split. Stock splits are done for several reasons that involve psychology and exchange requirements.
What New Investors Get Wrong About Stock Splits
The most important aspect to understand regarding stock splits is that they cause no economic change to the company. Stock splits are purely to lower a company's stock price to allow more individuals to purchase stock. A stock split is when a company increases the number of shares outstanding and, as a result, decreases the share price. Stock splits are usually announced in ratio terms such as "3-for-1," signifying how many shares an investor will receive for each of their already owned shares. For example, Apple announced a "4-for-1" stock split in July of 2020 when the stock was trading at approximately $400 per share. If you owned one share of Apple stock, you would have received four shares in exchange for the one share you already owned, and the price of each share would change to approximately $100 (4 x less) per share. The value of your investment in this example does not change, as the total value was $400 before the split and remains at $400.
Why Do Companies Split Stocks?
Companies usually announce stock splits to make their shares more accessible to retail investors interested in investing by lowering the cost of each share. By reducing the cost of shares, retail investors can gain access to shares they may not have been able to afford. In theory, you may be thinking that this would drive a company's stock up and maybe a good sign for a company. However, the minuscule amount of capital provided by these retail investors interested in a company does not really impact the stock price at all. In the modern age of computer trading, most brokerages offer fractional shares of stock, which means that a person could buy 0.5 shares of a stock trading at $100 per share for $50. This fractional trading has made stock splits much less common than they were in the 1980s and 90s. However, large companies, such as Apple, may choose to do this merely as a psychological marketing tactic to appeal to those who want to own entire shares but can't do so.
Also, stock splits can sometimes be seen as a sign of confidence in a particular stock. It could be argued that a company that is willing to split its stock from $100 per share to $20 per-share is confident about the future growth of its stock price. While stock splits have no direct connection to the financial health or future performance of a company, some believe that they signify future strength to come for business. As a result, stocks can often rise after a stock split is announced, as Apple did because it is believed that company executives are confident in the future of the business.
Different Types of Splits
Another type of stock split is known as a reverse stock split. A reverse stock split is the exact opposite of a regular stock split. While a regular stock split seeks to reduce the price of shares by issuing more shares, a reverse stock split aims to raise the price of individual shares by merging existing shares. A reverse stock split essentially lowers the number of shares outstanding, which results in a higher stock price. Reverse stock splits are also announced in ratio terms such as "1-for-3". In a "1-for-3," reverse stock split example, an individual who owns three shares of stock X trading at $1 per-share would receive one share that costs $3 per share. The value of your investment in this example does not change just as with regular stock splits, as the total amount was $3 before the split and remains at $3.
Reverse stock splits are typically a terrible sign compared to the generally positively received regular stock splits. Companies perform reverse stock splits when the stock price has usually reached record lows. Companies will perform reverse stock splits to raise the share price to above the minimum level required by some exchanges. Both the NASDAQ and NYSE require that stock prices remain above $1 per-share to stay listed on the exchanges. If a company's stock has fallen close to $1, they may consider a reverse stock split to raise its share price to remain listed on the exchange. The NYSE requires that at least 1.1M shares be traded for a company, and the NASDAQ requires that at least 1.25M shares be listed. This means that a company cannot reverse stock split forever to maintain its stock price; eventually, the stock will be delisted from the exchange and become a "penny stock" that trades on the OTC. Reverse stock splits are not a good sign. Don't be fooled by the rising stock price, as reverse stock splits do not alter the value of your investment and signal company struggles.
Conclusion
Next time you see a sudden change in the number of shares you own in stock due to a stock split, don't be alarmed. These corporate actions do not alter the value of your investment but could potentially signal confidence around the future of the stock price. If a reverse stock split is announced, don't get excited that the share price has risen because it has no impact on your investment value as the number of shares you owned was proportionally decreased. If a reverse stock split was announced, consider looking for new investments as the company may be indirectly signaling tougher times ahead.
Submitted August 12, 2020 at 05:40PM by mediusresearch https://ift.tt/30RlBl2
