What is a Stock Split?
A couple of months ago, Apple and Tesla, split their stock. Apple did a four-for-one split and Tesla split its stock five-for-one. This made big news, but it is not always clear to the general public what this means.
What is a Forward Stock Split?
A stock split, or more specifically, a forward stock split, involves a decision by a publicly traded company to increase the number of shares in the stock market. A typical example might be a two-for-one split.
Let’s imagine a company worth one billion dollars. Each share is currently priced at $100. That means there are 10 million shares outstanding. The company observes that the high price means that fewer people are owning their shares and they are not trading as frequently as they used to. They therefore announce a two-for-one stock split. Assuming the value of the company holds steady, the result will be 20 million shares outstanding with each share now priced at $50. The company is still worth one billion dollars. If you are an individual shareholder and before the split you owned 100 shares worth $100 per share, the value of your position would have been worth $10,000. After the split, you would have owned 200 shares worth $50 per share. That is still worth $10,000. If the company had opted for a four-for-one split, then you would have had 400 shares worth $25 per share.
Board Lots or Standard Trading Units
Many companies announce stock splits. In bygone days, trades were often done in multiples of 100, referred to as a board lot or a standard trading unit. The idea is that trading in standardized units results in more efficient markets and therefore lower costs. These days, especially with stocks that trade in large volumes, although standardized units remain in place, trading in so-called “odd lots” (order sizes of less than 100 shares) is common and very seldom an impediment to execution. Having said that, if you search for a stock quote, you may see something like this and wonder what it means:
The bid price of $122.12 refers to the best price a potential buyer is willing to pay. The 7, referring to lots, means that there are 700 shares (100 shares per lot x 7 board lots) being bid at $122.12. The ask price of $122.14 refers to the best price a seller is willing to sell at. The number 3 in this case refers to 300 shares (100 shares per lot x 3 board lots) being offered at $122.14. This means, among other things, that if you are trading in less than board lots, your order may not be visible to the public. That does not mean the order will not get filled, however.
You may wonder about lot sizes for stocks that trade at low prices. In Canada, the breakdown is as follows:
|Security’s Closing Price||Standard Trading Unit (Board Lot)|
|Under $0.10||1000 shares|
|$0.10 to less than $1.00||500 shares|
|$1.00 and up||100 shares|
Imagine a security starts the day at $1.05 per share. Bids and asks will be posted in 100-share lot sizes throughout the trading day. However, if its closing price that same day is $0.95, during the next trading day each lot will represent 500 shares.
The Most Expensive Stock per Share
The head of Berkshire Hathaway, Warren Buffett, has never split the A class shares (BRK.A) of the stock. Its share price is like nothing else you have ever seen. As I write this, it last traded at (US) $325,189.42. One might think that it is ripe for a stock split, but the company is not interested in attracting active traders. I have occasionally spoken with retail investors who hold shares in BRK.A but they typically own only 1 to 3 shares. Not unexpectedly, its board lot size is 1.
What is a Reverse Stock Split?
A reverse stock split, also called a stock consolidation, is when a company decides that its stock price has dropped too low and wishes to make its price per share higher. When stock prices drop too low, that typically reflects poor prospects for the company. Depending on the exchange, it might become de-listed. For example, among other things, the New York Stock Exchange requires that stocks trade at not less than $1.00 per share. A low price might also mean it will no longer be eligible for consideration by, for example, mutual fund companies that are looking for investments.
Reverse stock splits are most often seen among very small companies. Some stocks are bought and sold based on pure speculation that they will eventually do something profitable. But sometimes they get too small. For example, a stock might trade at $0.001, one-tenth of a cent per share. It might choose to do a reverse split. Let’s suppose you own 100,000 shares. That means your position is worth $100 (100,000 x $0.001). If the stock does a 1 for 100 reverse split your 100,000 shares will be replaced by 1,000 shares worth 10 cents per share, or $100.
What is the Impact on Dividends?
If you have a stock that pays dividends, you may wonder what happens to the money you look forward to receiving every three months. As you have seen, nothing really changes in terms of the value of your position when your stock undergoes a split. The same can be said for dividends.
As an example, Toronto-Dominion Bank, one of the big banks in Canada, underwent a 2-for-1 stock split on February 3, 2014. TD was trading at around $100 per share at that point and its most recent quarterly dividend was $0.86 per share. That worked out to about 3.44% per year. If you had 100 shares you would have received $86 from the last dividend. After the split, the price dropped to the $50 range, the dividend dropped to $0.47 (TD increased their dividend slightly after the split) and you would have had 200 shares. At your next dividend payment, you would have received $94 (200 x $0.47). The price had risen to the $53 range by that time. The resulting dividend, on an annualized basis, was about 3.55%.
The Bottom Line
There is no real impact from a stock split. Two analogies from The Motley Fool website may be helpful to understand. In the case of Apple’s stock, it is as though you owned an apple and then cut it up in four pieces so that you could eat them a little more conveniently. Another way of thinking about it is if you needed some change. Typically, you would use the occasion when you went to the store to do some shopping. You would ask the cashier to take your loonie and give you four quarters instead. Either way, you still have a dollar. So it is with stock splits.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.