Wondering what a stock split is? So imagine this: you have a company, and it has issued shares of stock to investors. These shares represent small pieces of ownership in the company. Let's say the company's stock is doing well, and each share is now worth a lot of money. This can sometimes make it harder for new investors to buy shares.
To make shares more affordable and attractive to more investors, the company might decide to do a stock split. In a stock split, the company divides its existing shares into multiple new shares. Keep reading to learn more.
What is a stock split and how does it work?
A stock split happens when a company decides to increase the number of its shares. The goal is to make the stock more affordable and easier to trade. When a stock split occurs, the number of shares goes up, but the total value of the company stays the same.
How does it work?
Imagine you own 1 share of a company, and it's worth $100. The company announces a 2-for-1 stock split. After the split, you will have 2 shares, but each one will be worth $50. So, you still have $100 worth of stock, but now it's divided into two shares instead of one.
The most common split ratios are 2-for-1 or 3-for-1. Here’s what these ratios mean:
- 2-for-1 split: For every 1 share you own, you get 2 shares. If you had 1 share, now you have 2 shares.
- 3-for-1 split: For every 1 share you own, you get 3 shares. If you had 1 share, now you have 3 shares.
Even though the number of shares you own increases, the overall value of your investment remains the same. This is because the price of each share is adjusted according to the split ratio.
Why do companies do stock splits?
- Affordability: Lower share prices make it easier for more people to buy the stock.
- Liquidity: An increase in shares leads to heightened trading activity, facilitating the buying and selling of stock, similar to the way the Nickel price chart reflects increased activity during favorable market conditions.
- Market perception: A lower price per share can make the stock seem more accessible and attractive to small investors, much like how the value of gold could attract new buyers when prices drop.
In summary, a stock split is a way for a company to make its shares more affordable and increase trading activity without changing the overall value of the company or the investments of its shareholders.
Stock split example in real world
Let's look at a real-life example of a stock split using Google, now known as Alphabet Inc.
What happened?
In July 2022, Alphabet Inc. announced a 20-for-1 stock split. Here’s how it worked:
Before the split
- Suppose you owned 1 share of Alphabet Inc.
- The price of one share was $2,000.
After the 20-for-1 split
- For every 1 share you owned, you received 20 shares.
- Instead of having 1 share worth $2,000, you now have 20 shares.
- The price of each share was adjusted to $100 ($2,000 ÷ 20).
So, if you had 1 share worth $2,000 before the split, after the split, you would have 20 shares, each worth $100. The total value of your shares would still be $2,000. In the case of Alphabet Inc., a 20-for-1 stock split turned 1 expensive share into 20 more affordable shares, making it easier for more people to invest in the company.
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Advantages and disadvantages of stock split
| Advantages | Disadvantages |
|---|---|
| Affordability: A stock split lowers the price per share, making it more affordable for small investors to buy the stock. | No real value change: A stock split doesn’t change the overall value of the company or your investment. |
| Increased liquidity: With more shares available at a lower price, it's easier for investors to buy and sell the stock. | Increased volatility: With more shares available, there can be more ups and downs in the stock price. Lower prices can attract short-term traders who might cause more price swings. |
| Market perception: A stock split can be seen as a sign that the company is doing well, which could attract more investors. | Costs: The company incurs costs to manage the stock split process. Splits can sometimes confuse investors who are not familiar with how they work. |
Summary
Stock splits have both benefits and drawbacks. They can make shares more affordable and increase trading activity, but they don’t change the real value of your investment and can lead to more price fluctuations.
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