If you’ve been paying any attention to financial headlines this summer, you’ve probably caught a headline (or several) about stock splits. Some notable companies are going through their own splits soon, and others are rumored to be next.
We’re clearing up some common myths about these market maneuvers to help you better understand what stock splits are and what they mean for everyday investors like you.
Stock splits are going out of style.
TRUE … Sort of. The number of stock splits has been on a steady decline since 1990. However, big companies like Apple and Tesla split in the past year, in part, to make their share prices more accessible to retail and individual investors. Up next? Chip maker Nvidia.
Stock splits create value for investors.
FALSE. Stock splits ≠ higher market cap (in a vacuum). A stock split simply divides the same amount of pie into more slices. If a stock with 100,000 shares outstanding is trading at $10, its market cap is $1 million. Say that stock goes through a 5-for-1 split — then investors will receive five shares for each share they own. The number of shares outstanding increases by a factor of 5 and the share price decreases by a factor of five.
Post-split, the stock would have 500,000 shares outstanding and be priced at $2 per share. Yet it still has a $1 million market cap. However, the new lower share price could make the stock more attractive to retail investors since low-priced stocks tend to catch the spotlight more. And more interest could mean more buying (or more liquidity).
Stock splits can happen in reverse.
TRUE. Reverse stock splits can happen, too! In this scenario, a company effectively bundles multiple shares into one, increasing its share price. When a stock with 100,000 shares outstanding that trade at $10 goes through a 1-for-5 reverse stock split, you will receive one share (priced at $50) for every five you own.
If you own an odd number of shares, the company can compensate you in other ways, like paying cash for leftover shares.
Some important things to know about reverse stock splits:
- Reverse stock splits don’t create new value for investors. Companies tend to do them when they’re trying to stay listed on an exchange (with minimum share price requirements) or when the company is trying to improve its sentiment. They may also occur before a spin off or sale.
- Reverse stock splits tend to be more common in smaller companies. However, you’ll occasionally see one in the large-cap wilderness. For example, General Electric (a $114 billion company) is about to undergo a 1-for-8 reverse stock split at the end of July.
Stock splits are a positive sign for the future of the company.
TRUE … Sort of. Stock splits aren’t like dividends, which typically signal a company is flush with cash. They do tend to occur with higher-priced shares (and there’s usually a reason why those shares’ prices are so high, like a recent rally). Reverse stock splits could be a negative sign for the future (for instance, a company getting delisted, a lack of investor interest, etc.), but that’s not a definite either.
Bottom line: Don’t read too much into a stock split!
Stock splits can impact your options positions.
TRUE. When a stock splits, the options contracts split as well. For example, let’s say the stock undergoes a 4-for-1 split (that’s four shares for every one). If an options trader currently has one option contract in their account, the investor will keep that contract and will be given three more to make the total four contracts. But the exercise price (often referred to as the strike price) of all the contracts in the position will be divided by four and rounded off, which means the trader may have a decimal in the strike price of the “new” options contracts. (Also, the price of the options contract will be a quarter of the price before the split.)
The result? Lots of options contracts to trade with lots of strike prices. And more strike prices could mean more headaches.
Fractional strike prices could equal lower liquidity (fewer active buyers and sellers), which could make it tougher to trade in and out of a position if you need to get out. Which could also lead to a wider bid/ask spread when you trade, which could eat into your profitability or add to your loss in the end.
Ultimately, option holders need to know that there are a lot of factors to consider when it comes to stock splits, but in the end the goal of the exchanges is to make sure you have the same market value in your account as you had before the split — just like stock positions.
Stock splits require you to watch the calendar.
TRUE. A stock split has multiple steps and dates to watch. So, you’ll want to be ready to pencil these in your planner:
- The Record Date: This date determines which shareholders are entitled to receive new shares related to the split. You must own shares on the record date to receive the additional shares of issued stock. If you sell the stock after that date and before the stock split occurs, you will not be eligible to take part in the split.
- The Split Date: The effective date, or the date shareholders receive the additional shares (after the close of business).
- The Ex-Date: The date when common shares will trade at the new split-adjusted price.
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Callie Cox, senior investment strategist, contributed to this article.
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Lindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.
Lindsey holds a passion for teaching individuals how to become successful long-term investors. She is a contributor at CNBC, and frequently shares her insights with various publications including the Wall Street Journal, Barron’s, MarketWatch, BusinessInsider, etc. She also serves on the board of Better Investing, a non-profit organization focused on investment education.
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The opinions expressed here are not meant to be used as investing advice. For more information, visit our website.
Options involve risk and are not suitable for all investors. Review the Characteristics and Risks of Standardized Options brochure before you begin trading options. Options investors may lose more than the entire amount invested in a relatively short period of time.