I recently discussed how shares of stock come to be. Sometimes shares of stock rise to very high prices. In the interest of liquidity, many companies prefer to keep their prices low. Low share prices allow more people to invest in a company. If the share prices goes too high, the company can initiate a stock split.
For this split, I will use a made up situation involving a made up company X. If company X stock is trading at $100 per share, the board of directors may decide to do a 2:1 split, called a two to one split. A 2:1 split would lower the price per share to $50 while doubling the number of shares outstanding.
For the investor, this is a no cash impact transaction. If an investor owned 10 shares at $100 each, they owned $1000 of company X stock. After the split, they own 20 shares at $50 per share, for a total of $1000.
Stock splits do not have to be 2:1. If company X did a 4:1 split, each investor would get 4 shares for every one owned and each share would be worth $25. A 5:1 split would result in 5 shares at $20 per share.
A company can also issue a reverse split. If a stock goes too low, a company can cut the number of shares and raise the price. If a stock trades at $1 per share, a company can do a 1:5 split. For each 5 shares of stock worth $1 per share, an investor would end up with 1 share worth $5. This action can quickly increase a stock price to keep a stock listed if it is facing de-listing from a major market due to a low share price.
Some companies choose not to split and would rather have only wealthy investors buy their stock. Berkshire Hathaway, for example, trades at $90,660 per share. That high price prevents many investors from buying the stock. A large stock split could allow many new investors in the company.
Each company can decide whether or not to split. Splits can be good or bad for a company depending on the circumstances. It is important for investors to know how they work and why they happen. This can help investors to make wise investment decisions in any market condition.
