Understanding Stock Splits: What They Are and How They Impact Investors
News Flash - they aren't that cool...
It wouldn’t be a normal day in the finance world if we didn’t mention Nvidia at some point.
Most recently, Nvidia is in the news because they did a 10 for 1 stock split. Broadcom followed suit and announced a 10 for 1 stock split last night.
This has created more excitement around these names but you may be thinking to yourself, ‘what exactly are stock splits?’ and ‘how do these affect me as an investor?”
Let’s explore…
What are stock splits?
A forward stock split occurs when a company increases the number of shares outstanding to make its stock more affordable to investors. For instance, a 10-for-1 stock split changes a stock trading at $1,000 per share to $100 per share, multiplying the number of shares held by investors tenfold.
The opposite is true for a reverse stock split - they are reducing the number of shares outstanding, therefore increasing the stock price. The reverse splits can signal the company is going through challenging times and they have to massage the numbers to prevent being delisted or removed from certain funds/indices.
To be very clear - a stock split doesn't increase the value of the company or the value of your holdings.
They simply increase the number of shares you own at a proportionally lower price, which can attract a broader range of investors who now think the stock is “cheap”.
What are the benefits?
By lowering the share price, companies make it easier for new and existing investors to buy shares, thus broadening their ownership base. We are humans after all. If someone see’s a stock trading at $1,000/share, they immediately think it’s expensive without even considering the current market cap.
Although I make the point above that a split doesn’t increase the value of the company, it’s certainly can provide a short-term boost. Lowering the share price can influence your perception and behavior. And if you own more shares post-split, you might have greater growth potential on your investment.
Companies will typically initiate a forward stock split when they anticipate continued growth and profitability.
Do I owe taxes during a stock split?
Stock splits are not taxable events. However, they can be a pain in the ass for you in keeping track of your cost basis. I’ve seen investors not have a cost basis on large holdings and trying to calculate this, with multiple historical splits, can be a nightmare.
What is the most common split ratio?
A 2 for 1 stock split is arguably the most common but we’ve seen a few 10 for 1 splits as of late. Companies can actually do a fractional split as well, Tootsie Roll did a 1.03 for 1 split in March 2024. Sounds like they prefer complexity over in tootsie land…
The main takeaway is, never buy a stock simply because it is doing a stock split.
We buy stocks to become owners in some of the most profitable and well run companies in the world. Who gives a shit if they split the stock? Buy and hold.
Yeah, lower share prices may seem attractive to you. But sometimes they can look good from far, but are far from good…
This video is a good representation…
Disclosure: This material is for general information only and is not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
All indices are unmanaged and may not be invested into directly.
All investing includes risks, including fluctuating prices and loss of principal.