What are Stock Splits and How Do They Affect Investors and Traders?

Updated July 29, 2022 GuidesTrending

On 15 July 2022, Google’s parent company Alphabet will execute a 20-1 stock split. This follows similar stock split moves in 2022 by Amazon (20-1) and Shopify (10-1).

As a long-term investor or a day trader, it might make you wonder how would stock splits impact your investment plan, and whether such moments present the right trading opportunities.

Here’s what you may need to know about how stock splits work, and how your positions might be affected before, during and after a stock split.

What is a stock split?

As its name suggests, a stock split is the process a public company undertakes to divide existing shares by a certain ratio.

In effect, this process increases the number of shares issued, without altering the proportion of shareholders or the market capitalisation of the company.

For example, imagine there is a company with 1,000 shares issued, each worth $1,000. The market capitalisation of the company would be $1,000 x 1,000 = $1,000,000. If it performs a 2:1 stock split, there will now be 2,000 shares issued, each worth $500.

This means that for every share investors previously held, they would now hold two shares – with the value of their investment remaining the same, all things being equal.

Why do companies perform stock splits?

One common reason companies perform stock splits is to bring down their stock price. Since stock market trades need to happen in lots (of 100 or 1,000), a high stock price might be prohibitive for investors with less capital or those who would rather diversify their investment portfolio.

A stock split thus makes owning (smaller-size) shares of the company more accessible, which contributes to improving liquidity.

For companies that offer stock options to employees, stock splits would allow employees more flexibility in cashing out part of their stock holdings, as well as make it more affordable for employees to opt into exercising their stock options.

A side effect of stock splits by prominent companies is that it drives publicity after the announcement of a stock split plan and in weeks leading up to the stock split execution. The boost in investor interest is a welcome upside, but is unlikely to be a significant driver of stock split decisions.

How a stock split is executed

There are four key dates on which key stages of the stock split process take place.

Announcement Date: This is when the company makes an official, public announcement of the stock split, disclosing details such as the stock split ratio and subsequent dates of the subsequent two stages.

Record Date: This is the cut-off date on which shareholders would need to be holding the company’s stock in order to be eligible for the issuance of new shares from the stock split. This date is more of a technicality, since investors can still buy or sell shares afterwards, with the right to receive additional shares would be transferred accordingly.

Effective Date: Abbreviated as the ‘ex-date’, this is the date on which the company’s stock begins trading on the exchange at its split-adjusted price.

Payment Date: Also known as the ‘pay date’, this is the date on which the stock split is officially completed. In accordance with the split ratio, new shares are transferred to investors and will be reflected in their brokerage accounts.

Notable stock splits in recent history

Here are some notable stock splits of major companies that have taken place recently – and one that might take place soon.

Amazon: 20-1 split in May 2022.

Shopify: 10-1 split in June 2022.

Alphabet: 20-1 split in July 2022.

Tesla: Proposed 3-1 split with a date to be announced.

Should I buy the stock before or after the split?

There is usually a lot of media attention and investor interest surrounding a stock split, which could work in favour of, or against the company. On one hand, it might drive renewed interest in the stock but on the other, it could come with additional scrutiny.

Regardless of what direction the stock price takes post-split, it is not uncommon to observe a short period of increased volatility where opportunists and traders alike have jumped on the bandwagon.

It is worth remembering that a stock’s sticker price is hardly the most important indicator investors and traders look at when planning their trades.

Day traders are more likely to examine trading volume data and attempt to discern momentum from trading charts. Long-term investors, on the other hand, might be more interested in the company’s growth prospects, industry trends, the strength of its balance sheets, and whether the management team is a good one.

So, while the media and pundits tend to make a big deal out of stock splits, it would be wise for serious investors and traders to tune out the noise and plan their trades with the same care and diligence they usually take.

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