Share splits are (back) in the news, courtesy of Apple and Tesla, which announced splits of 4-to-1 and 5-to-1 respectively. This is Apple’s fifth share split, its previous split was 7-to-1 and before that, it had three splits of 2-to-1. Here are the key points for investors to take away.
The overall value of your holding remains the same
Possibly the most important point to understand about a share split is that the overall value of your holding remains exactly the same as do your voting rights. All that changes is the number of shares you hold. For example, if you hold one share worth £200 and the company does a 4-to-1 split, then you will end up holding four shares worth £50 each.
There is no commission or tax to pay because you are not buying or selling shares. All that’s happening is that the company is changing the way it issues shares.
Share prices become more affordable, this can boost demand
Lower prices are easier for people to afford than higher prices. Therefore, having more shares with a low individual value can stimulate demand for them. This will, of course, tend to increase their value. If a stock’s value increases to the point where it becomes unaffordable again, then the company can do another split.
Splitting can boost liquidity
Although demand and liquidity are often closely connected, they are different. Demand reflects how many people want a stock and how much they want it. Liquidity reflects how easy it is to buy or sell a stock.
When a stock has good liquidity, investors know that they will be able to adjust their holdings easily. More specifically, if a stock has high liquidity, it makes it easier for investors to fine-tune their portfolios. For example, if they like a stock, but feel that they are a bit over-exposed to it, they may wish to sell a small part of their portfolio. Similarly, if they want to increase their exposure to it, but cautiously, they may want to buy a few more shares.
In short – the difference between share splits and share issues
When a company issues new shares, existing investors gain no benefit from them. In fact, they may even be placed at a disadvantage. For example, even if the new shares are initially priced at the same level as the old one, the company’s profits will have to be spread more widely.
This may mean that share prices increase at a lower rate and/or that dividends are lowered. That said, all of this may still be worthwhile if the extra share capital can be used to generate better returns for all investors.
When shares are split, however, all the new shares are placed in the hands of existing investors. Nobody directly gains and nobody directly loses. That said, if the split improves demand and/or liquidity, then investors may see indirect gains.
Reverse stock splits explained
A reverse stock split is when companies consolidate their shares. As with regular stock splits, the overall value of the holding would remain the same. Liquidity would be reduced, but this might not be an issue depending on how the reverse split was conducted. Demand might or might not be impacted.
Reverse splits are generally done for one of two administrative reasons. Firstly, some stock exchanges have minimum prices for the stocks on their listings. If a company regularly hovers around the base, they may just do a reverse split to make sure that they stay above it.
Secondly, if a company wants to create a spinoff entity, it may use a reverse share split to ensure both parts of the company are priced attractively. Time Warner used this strategy when it created Time Warner Cable.