Question of the Week: What is a stock split?

A publicly traded company splits its shares by issuing new shares to its existing shareholders in proportion to their current share holdings. In layman’s terms, in a stock split a company divides its existing shares into multiple shares to lower the per share price and potentially increase their liquidity.

The number of shares increases, but the total dollar value of all the shares remains the same. The split itself does not increase value. For example, let’s say a company’s stock was valued at $200 per share and there were a million existing shares. The total value of the shares would be $200 million. If the company were to do a 2-for-1 stock split there would now be two million shares each valued at $100 per share. The shares total value remains at $200 million.

A company might engage in a stock split for two reasons.

1 – The company believes its stock is too expensive for the public to trade. For example,  Apple’s stock price was nearing $700 in 2014. Apple did a 7-to-1 stock split. The price of the stock closed at around $645 per share before the split. The price of each share dropped to around $92 per share after the 7-to-1 stock split.

2 – A company wishes to increase the liquidity of its shares. This plays in part to the first reason, but it may not be done just because the price of the stock was extremely high. A stock split can increase liquidity of shares to make trading easier for buyers and sellers.