Publicly traded companies have a finite number of shares outstanding at any given time. A stock split is one tool that a company can use to increase the number of its shares outstanding.

What Is a Stock Split?

A stock split is a decision made by the company's board of directors to split the existing number of shares outstanding as a means to increase the number of shares outstanding in the market. This is done instead of issuing new shares of stock. A stock split does not dilute the percentage of ownership by any shareholder, the existing shares are simply split.

A typical stock split might be 2:1, where for every share currently owned, each shareholder will receive one extra share, but now worth half the price. For example, a shareholder who owns 100 shares prior to the split will now own 200 shares after the split. Splits of 3:1 or even 4:1 are not uncommon.

How Does a Stock Split Work? 

The goal of company management and the board of directors is to maximize value for their shareholders.

If in their estimation, the price of each share of stock is becoming too expensive, they may decide that a stock split is needed. One common reason is that they feel that the stock price has risen so high that many smaller investors may find it too expensive. This limits the number of investors that can purchase shares, which could limit the upside price potential of the stock.

For example, if a stock was selling at $120 per share and the company issued a 3:1 stock split, each shareholder would now own three shares for every one they previously owned at a price of $40 per share. A shareholder who had 10 shares for a total value of $1,200 (10 x $120=$1,200) would now have 30 shares for a total value of $1,200 (30 x $40=$1,200.)

The lower price per share might now make the shares more accessible for a larger number of investors.

A reverse stock split can also be done, it works in the opposite fashion as a traditional stock split. Under this scenario, the company reduces the number of shares outstanding, causing the price to rise.

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For example, in a reverse 1:2 split, a share holder with 100 shares at $50 per share would now own 50 shares worth $100 per share. Companies might do a reverse split to increase its share price to gain a level of respectability, or to possibly prevent the stock from being delisted by the stock exchange if its share price was too low.

With a stock split, the company will announce its intention to do the split and indicate that it applies to shareholders as of a certain date. Shortly after that date the shareholders will receive their additional shares.

What Are the Advantages of a Stock Split?

Companies use stock splits for a number of reasons.

  • They may feel that reducing the stock price increases the liquidity of the stock by making it more affordable to smaller investors. In theory, these investors will be more apt to buy the shares, increasing the stocks trading volume and its overall liquidity.
  • In some cases, a stock split can lead to an increase in the stock price due to the shares becoming more affordable to investors after the initial price decline after the split.
  • A stock split may be perceived by the investors as a sign that the price of the shares has been increasing and that the company feels the need to lower the price by doing the split. Investors may perceive the split provides value in the form of making the price more accessible and in turn buy shares post-split, providing a boost in the share price and the overall value of the stock.

Stock Split Examples

A high-profile example of a stock split in recent years was Apple (AAPL) - Get Apple Inc. (AAPL) Report splitting its stock 7 for 1 in June of 2014. Prior to the split the stock was trading at about $645 per share. After the split the stock was trading at just under $93 per share.

Since the split, the shares have increased, currently trading at about $185 per share, though this is lower than the stock's post-split high of about $233 per share. In spite of the price being off its all-time high price, the stock has handily outperformed the S&P 500 over the past three- and five- year periods as of this writing.

The board of directors of Blue Apron (APRN) - Get Blue Apron Holdings, Inc. Class A Report , the food delivery service, recently announced plans to do a reverse split of its Class A and Class B shares in the range of 1 for 5 and 1 for 15. The company's shares were trading at about 66 cents per share at the time of this writing. The company's objectives include avoiding delisting of the stock by the exchange.

Stock splits are a tool that companies can use to try to make their stock price more appealing to a wider range of investors. By themselves, stock splits do not create any value for shareholders. In many cases, however, they can increase share price over time by making the shares more accessible to a greater number of stock investors.