Stock Splits Explained

Charles Schwab

3 Nov 202303:14

Summary

TLDRThis script explains the concept of stock splits, highlighting two types: conventional and reverse. A conventional split increases the number of shares while decreasing their price, maintaining the company's total market value. Apple's 7-for-1 split in 2014 exemplifies this, where the market cap remained constant despite more shares at a lower price. Conversely, a reverse split raises share prices by reducing the number of shares, often to avoid delisting due to low prices. AIG's 1-for-20 reverse split in 2009 aimed to stabilize its stock price but did not prevent further decline. The script clarifies that stock splits do not guarantee value increase, urging investors to consider a stock's overall financial health.

Takeaways

📈 Stocks can fluctuate in various ways including going up, down, sideways, or experiencing unexpected events like splits.
🔄 There are two main types of stock splits: conventional and reverse, each affecting the share count and price differently.
🍰 A conventional stock split increases the number of shares while decreasing the price per share, keeping the total market value constant, similar to cutting a cake into smaller pieces.
📊 Apple's example in 2014 illustrates a 7-for-1 split, increasing the number of shares from about 861 million to approximately 6 billion, with the market cap remaining around $555 billion.
💰 Companies typically opt for a stock split when share prices are high to make the stock more accessible to a broader range of investors and potentially boost liquidity.
🤔 Contrary to a common belief, stock splits do not inherently guarantee an increase in a stock's value post-split; investors should consider the company's overall financial health.
🔄 In a reverse stock split, the company reduces the number of shares to increase the price per share, often as a response to falling below exchange listing price requirements.
⚠️ Stocks that fall below the minimum exchange price risk being delisted, which can prevent them from being traded on the exchange.
📉 The American International Group (AIG) performed a 1-for-20 reverse split in 2009 during the financial crisis to stabilize its stock price, but the stock continued to decline.
💼 The value of an investor's holdings remains the same after a stock split, as the total value of the company's shares does not change, only the number of shares and their individual prices are altered.
🧐 Investors should conduct additional research and not rely solely on the occurrence of a stock split as an indicator of future stock performance.

Q & A

What are the two types of stock splits mentioned in the script?
-The two types of stock splits mentioned are conventional and reverse stock splits.
What happens during a conventional stock split?
-A conventional stock split occurs when a company divides its existing shares into more shares, increasing the number of shares while decreasing the price of each share, keeping the total value of the company's shares the same.
Can you provide an example of a conventional stock split from the script?
-An example given is Apple's stock split in June 2014, which was a seven-for-one split, reducing the share price from about $645 to around $92 while increasing the number of shares.
Why do companies typically decide to split their stock?
-Companies typically split their stock when the share price is high to make it more accessible for investors, potentially increasing the stock's liquidity.
How does the total value of a company's market cap remain the same after a stock split?
-The total value of a company's market cap remains the same after a stock split because the increase in the number of shares is offset by the decrease in the price per share.
What is the effect on an individual investor's shares during a stock split?
-The total value of an individual investor's shares remains the same after a stock split, as the increase in the number of shares is balanced by the decrease in the price per share.
Is there a common misconception about stock splits mentioned in the script?
-Yes, a common misconception is that a stock's price will go up after a split, but the script clarifies that splits do not guarantee an increase in the stock's value.
What is a reverse stock split and why is it used?
-A reverse stock split is when a company decreases its number of shares to increase the price of each share, often used to meet minimum exchange listing requirements or to avoid being delisted.
Can you provide an example of a reverse stock split from the script?
-An example is the American International Group (AIG) which performed a one-for-20 reverse stock split in July 2009 to stabilize its stock price during the financial crisis.
What was the outcome for AIG after the reverse stock split in terms of investor attraction and stock volatility?
-Despite the reverse stock split, AIG's stock continued to fall, indicating that a higher share price did not necessarily attract investors or reduce volatility.
What is the general effect on an investor's investment value if they own a stock that undergoes a split?
-The value of an investor's investment will likely remain the same after a stock split, as the changes in the number of shares and their price per share balance each other out.

Outlines

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📈 Stock Splits Explained

This paragraph discusses the concept of stock splits, differentiating between conventional and reverse splits. A conventional stock split increases the number of shares while decreasing the price per share, maintaining the total market capitalization. The example of Apple's 7-for-1 split in 2014 illustrates this, where the share price dropped from $645 to around $92, but the total value of the company remained the same. The paragraph also clarifies that stock splits do not guarantee an increase in stock value and that investors should consider the company's overall financial health. It contrasts this with a reverse stock split, where the number of shares decreases to increase the share price, often to meet exchange listing requirements and avoid delisting. The American International Group (AIG) example in 2009 shows a 1-for-20 reverse split to stabilize its stock price, although the stock continued to fall afterward. The key takeaway is that the value of an investment remains the same post-split.

Mindmap

Keywords

💡Stock Split

A stock split is a corporate action that increases the number of a company's shares by issuing more shares to its current shareholders. It is a way to make the stock more accessible to a broader range of investors by lowering the stock's price per share. In the script, Apple's seven-for-one split is used as an example, where each share became seven, increasing the number of shares from about 861 million to around 6 billion, while the price per share decreased from $645 to approximately $92.

💡Conventional Stock Split

A conventional stock split refers to the process where a company divides its existing shares into more shares, thereby increasing the total number of shares while decreasing the price per share. The total market capitalization of the company remains the same. The script mentions that a conventional split is typically done when the share price is high to make the stock more affordable and potentially increase liquidity.

💡Reverse Stock Split

A reverse stock split is the opposite of a conventional split. It involves reducing the number of a company's shares to increase the price per share. This is often done to meet the minimum price requirements of stock exchanges or to attract investors who might perceive a higher-priced stock as more valuable. The script provides the example of AIG, which performed a one-for-20 reverse split during the financial crisis to stabilize its stock price.

💡Market Capitalization

Market capitalization, or market cap, is the total value of a company's outstanding shares of stock. It is calculated by multiplying the stock's price by the number of outstanding shares. The script emphasizes that a stock split does not change the market cap, as the total value of the company's shares remains the same, regardless of the number of shares or their individual prices.

💡Liquidity

Liquidity in the context of stocks refers to the ease with which an asset can be bought or sold without affecting its price. The script explains that a lower stock price after a conventional split can potentially increase a stock's liquidity by making it more accessible to a larger number of investors.

💡Outstanding Shares

Outstanding shares are the total number of shares of a company's stock that are held by all its shareholders, including institutional investors and company insiders. The script uses the term to describe the change in the number of shares before and after Apple's stock split.

💡Share Price

Share price is the current market value of a single share of a company's stock. The script discusses how a stock split can affect the share price, either by decreasing it in a conventional split or increasing it in a reverse split.

💡Delisting

Delisting is the removal of a company's securities from a stock exchange due to non-compliance with the exchange's listing requirements, such as minimum share price or other financial criteria. The script mentions that companies may perform a reverse stock split to avoid delisting if their share price falls below the exchange's minimum requirements.

💡Investor Perception

Investor perception refers to how investors view and interpret various aspects of a company, including its stock price and financial health. The script suggests that a higher stock price after a reverse split might be perceived as more valuable by investors, although it does not guarantee an increase in the stock's actual value.

💡Financial Health

Financial health refers to the overall financial stability and performance of a company. The script advises investors to look beyond stock splits and consider a company's financial health when making investment decisions.

💡Exchange Listing Requirements

Exchange listing requirements are the criteria that a company must meet to have its securities listed on a stock exchange. The script explains that a reverse stock split can be used to meet these requirements, particularly the minimum share price, to avoid being delisted.

Highlights

Stocks can move in various directions: up, down, or sideways, and may sometimes behave unexpectedly.

There are two types of stock splits: conventional and reverse.

A conventional stock split increases the number of shares while decreasing the price per share, keeping the total value constant.

The analogy of cutting a cake is used to explain how a conventional stock split works.

Apple's stock split in June 2014 as an example of a conventional split, changing from 861 million shares at $645 each to about 6 billion shares at $92 each.

Despite an increase in the number of shares, Apple's market cap remained the same at approximately $555 billion after the split.

Stock splits are typically conducted when share prices are high to make them more accessible to investors.

A lower share price post-split can potentially increase a stock's liquidity by attracting more investors.

The total value of an investor's shares remains unchanged after a stock split.

Investors should not expect a stock's price to automatically increase after a split; additional research is advised.

A reverse stock split is the opposite of a conventional split, reducing the number of shares to increase their price.

Companies may enact a reverse stock split to avoid being delisted from an exchange due to low share prices.

AIG's reverse stock split in July 2009 as an example, changing from 20 shares at $1 each to 1 share at approximately $23.

A higher share price post-reverse split does not guarantee increased investor interest or reduced volatility.

The value of an investment remains the same regardless of whether a stock undergoes a conventional or reverse split.