Stock Splits: How They Work



Since mid-August, there has been a lot of buzz around the Apple and Tesla stock splits. Apple, which did a 4-for-1 stock split, saw its share price go from around $500 to $125. Elon Musk 'nem performed a 5-for-1 stock split and saw their share price go from $2,213 to $444. So, what exactly does this mean?


How Stock Splits Work

Every public company has a specific amount of shares; some have hundreds of thousands, some have millions, and some even have billions. When a company decides to do a stock split, they take each share and split it into multiple pieces, creating additional shares. It's like going into the corner store and getting four quarters for $1. The value of money didn't change, just the way it's presented.


Suppose locksmith company Bruh Man From The Fif Flo had 100,000 total shares. If the company decides to do a 2-for-1 stock split, they'll now have 200,000 shares; if they choose to do a 4-for-1 stock split, they'll now have 400,000 shares; and so on.


Now, let's suppose restaurant chain Uncle Elroy's BBQ Shack (which isn't a real chain, but the name sounds like their food would be fire!) had 1 million shares priced at $100 each. This means Uncle Elroy's BBQ Shack would be worth $100 million (known as its market capitalization).

If Uncle Elroy 'nem decide to do a 4-for-1 stock split, they'll now have 4 million shares priced at $25 each ($100 ÷ 4). The number of shares changed, the price of the shares changed, but Uncle Elroy's BBQ Shack is still worth $100 million.

If you owned 10 shares before the split, you had $1,000 worth (10 shares * $100); after the split, you still have $1,000 worth (40 shares * $25).


The Role of Stock Prices

A company's stock price is always based on supply and demand. Companies have a specific number of shares available, so someone has to be selling shares for you to buy them, and vice versa. The more people buying a stock, the higher the price goes; the more people selling a stock, the lower the price goes.

You know how it seems like the more successful you get, the more "cousins" you have? It's almost like that. As a company becomes successful, more people want to own a piece of it, so they buy shares, making the price rise. Eventually, this causes a company's stock price to be higher than what the average investor can afford.

When shares are a couple of hundred dollars or less, many people can afford to buy at least one. When shares start becoming thousands of dollars, not so much. And while companies benefit from a higher share price, they also benefit from an increased number of investors.


Fractional Shares

Before platforms came along that allowed you to buy fractional shares, you had to pay for the full price for a company's share if you wanted to invest in them. If the price was $1,500, you had to pay $1,500. If it was $10,000, you had to pay $10,000.

This presents a problem after a while because the higher the price, the more it starts weeding out potential investors like Chem and Bio 101 do college freshmen with dreams of going to medical school.


Nowadays, a lot of platforms will let you invest in a company with as little as $1. For less than the price of guacamole at Chipotle, you could be a part-owner in Amazon, Apple, Nike, or whatever your #investing ass heart desires. Your ownership percentage will be smaller than the amount of Black folks in Vermont, but you'll still technically have some ownership, nonetheless.

Because you can buy fractional shares from most brokerages now, stock splits don't mean as much for investors and potential investors. The price may be lower, but the value is the same—which is the important part. A low stock price doesn't mean a stock is a good value, just as a high stock price doesn't mean it's a bad value.

Note: Companies can do reverse stock splits. Instead of multiplying the number of shares, they divide them, decreasing the number and raising the price of each. A company with 100,00 shares doing a 4-for-1 reverse stock split would end up with 25,000 shares.

What stock splits mean for your portfolio.
Stefon Walters
September 16, 2020
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