 Personal Finance PowerPoint Presentation, Stock Split. Prepare to get financially fit by practicing personal finance. Most of this information comes from Investopedia Stock Split, which you can find online. Take a look at the references, resources, continue your research from there. This by Adam Hayes, updated June 7th, 2022. In prior presentations, we've been taking a look at investment goals, investment strategies, investment tools, keeping the primary two categories of investment in mind. That being fixed income, typically bonds, equities, typically stocks. We're focusing on the equities stocks side here. Let's recap what stocks are. Corporations are a separate legal entity. They're going to break out ownership into stocks. Each stock represents an equal ownership to the corporation. So the stocks are all the same in nature would be the general idea. Then the corporation may choose to go public trading on a public exchange, making it easier for individual investors to purchase and sell those stocks that are publicly traded. Those are typically the stocks that we are talking about when we are investing in stocks. Keeping that in mind, we're asking what is a stock split? A stock split happens when a company increases the number of its shares to boost the stock's liquidity. Now, note when we think about the stocks themselves, we call them kind of the equity. It's an equity type of investment because when you look at it from an accounting standpoint, the equity represents in essence kind of the book value, the value of the company, the amount of the ownership that you go to the owners. In other words, if you look at the accounting equation, assets equal liabilities plus equity, which you can rewrite as assets, what the company has minus liabilities, what the company owes to third parties equals equity, which you could think of as basically net assets, assets minus liabilities. That's kind of the value of the company, which you would think would be represented in the stock price. The stock price should be representing what the market feels is the equity value, the ownership interest in the company. And it's represented by these shares, which represent an equal value of the company. So if you were to then double the number of shares, so each share then is going to be valued, you would be thinking based on that underlying value of the company. If you split the stocks, then what's going to happen is you're going to have twice as many shares out there would be the general idea more shares now in the market. What's that going to do? Let's read on. Although the number of shares outstanding increases by a specific multiple, the total dollar value of all shares outstanding remains the same because a split does not fundamentally change the company's value. In other words, oftentimes, or if you wanted to increase the number of shares that were out there, you could do so the company could choose to issue more stocks out there. If they did, then they would be issuing stocks for cash. As they get cash, that would be increasing the value of the company because it would be going into the equity section. In this case, they're not doing that. They're just taking the number of stocks currently out there and doubling them, which means that there's no underlying difference in the valuation of the company from a book value perspective, meaning assets minus liabilities equals the same amount of equity. It's just now being represented by twice as many shares at that point. Going on, the most common split ratios are two for one or three for one, sometimes denoted as two colon one or three colon one. This means for every share held before the split, each stockholder will have two or three shares respectively after the split. If you're holding on to one stock and there's a stock split and it was a two for one, you would then have two stocks after that. If you had five stocks and it was a two for one, you'd have 10 stocks after the split. Going on, how a stock split works. A stock split is a corporate action in which a company issues additional shares to shareholders increasing the total by the specified ratio based on the shares they held previously. Companies often choose to split stocks to lower its trading price to a more comfortable range for most investors and to increase the liquidity of trading in its shares. So in other words, if you're holding on to one share and it doubles to two shares, you would think theoretically there's been no real change to the underlying value of what you are holding. Meaning you had one share that represents a bigger portion of the ownership or equity in the company. Now you have two shares that represent half as much each representing half as much because there's twice as many shares out there. So in theory, the two shares should represent the same value that the one share did before the stock split happened. So why would the company do a stock split? Well, perhaps the shares are getting expensive in value. Because the company has been growing and perhaps they're not in that sweet spot where they think the company's stocks can generate the most earnings or be most attractive to investors. So maybe they're going to try to decrease the price of the stocks to a more acceptable level or level better for trading purposes, increasing the value of the stocks, possibly of the desirability of them, increasing the value by making it a lower price for each individual stock. So most investors are more comfortable purchasing, say, 100 shares at $10 stock as opposed to one share at $1,000 stock. So if I'm buying one share and it costs $1,000, that seems kind of pricey. Most people would be saying if the price was around $10 and I get 100 shares, most people prefer that trade. That's why they might say, OK, well, let's see what we can do in terms of a split to get our price around the range where most people are comfortable. So when the share price has risen substantially, many public companies end up declaring a stock split to reduce it. Although the number of shares outstanding increases in a stock split, the total dollar value of the shares remains the same compared with free split amounts because the split does not make the company more valuable. Again, no revenues going to the company. You just now have twice as many shares if it was a 2 for 1, which now theoretically would represent half as much for each individual share. OK, so a company's board of directors can choose to split the stock by any ratio. For example, a stock split may be a 2 for 1, 3 for 1, 5 for 1, 10 for 1, 100 for 1, etc. A 3 for 1 stock split means that for every one share held by the investor, there will now be 3. In other words, the number of outstanding shares in the market will triple. So on the other hand, the price per share after the 3 for 1 stock split will be reduced by dividing the old shares price by 3. So in other words, me as an individual investor should theoretically be left in the same position financially even though I now have in this case 3 shares instead of 1 share because I would have 3 shares that still now represent in total the same valuation of the 1 share before the split. So that's because the stock split does not alter the company's value as measured by market capitalization. So special consideration, market capitalization is calculated by multiplying the total number of shares outstanding by the price per share. For example, assume XYZ corp has 20 million shares outstanding and the shares are trading at $100. Its market cap will be 20 million shares times $100 or $2 billion. So let's say the company's board of directors decides to split the stock 2 for 1. Right after the split takes effect the number of shares outstanding would double to 4 million while the shares price would be halved to $50. So although both numbers of shares outstanding and the market price have changed the company's market cap remains unchanged at 40 million now this time times $50 which again is the $2 billion. So advantages of a stock split, why do companies go through the hassle and expense of a stock split? Because of course to do a stock split is costly because now you got to go through the whole process of doing a stock split. Why would they go through that process if it doesn't change the other underlying value if in other words unlike when they issue the stock they're not getting any money for these stocks. They're just changing the mix out there. So first a company often decides to on a split when the stock price is quite high making it expensive for investors to acquire a standard board lot of 100 shares. So second the higher number of shares outstanding can result in greater liquidity for the stock which facilitates trading and may narrow the bid ask spread increasing the liquidity of a stock makes trading in the stock easier for buyers and sellers this can help companies purchase their shares at a lower cost since their orders will have less of an impact on more a liquid security. While a split in theory should have no effect on the stock's price it often results in renewed investor interest which can have a positive effect on the stock price. So in theory we said that's why I keep saying in theory you're not going to be any change because basically there's been no underlying change in the equity. But the market is based on people's perception of what is happening so if there's a stock split it could be like a good indicator to the market which means that people it could be good in that case people might be looking at it and say well that's a good sign and therefore that more attractiveness to that stock could increase the stock price. So while this effect may wane over time stock splits made by blue chip companies are a bullish signals for investors. So a stock split may be viewed by some as a company wanting a bigger future runway for growth for this reason a stock split generally indicates executive level confidence in the perspective of a company. So that again there's no underlying change really to what the balance sheet says or the income statement but there is this perception which could be a good indicator which could be a spike at least in the short run based on that good indicator tool. So many of the best companies routinely see their share price return to levels at which they previously split the stock leading to another stock split. Walmart for instance split its stock 11 times on a two for one basis between the retailer stock market debut in October 1970 and March 1999 and investor who bought 100 shares in Walmart's initial public offering when they went IPO would have seen that stake grow to 204,800 shares over the next 30 years without any additional purchases which would be a nice disadvantages of a stock split. So not all facets of a stock split benefit a company the process of a split is expensive requires legal oversight and must be performed in accordance with regulatory laws. So clearly it's not an easy process to do it's going to be costly to do the stock split. The company wanting to split their stock must pay a great deal to have no movement and it's over market capitalization value. A stock split isn't worthless but it doesn't impact the fundamental position of a company and therefore doesn't create additional value. So in theory if you're looking at the fundamentals there's no real change in the fundamentals it's really that indicator kind of thing that could have an impact on the market price. Some compare a stock split to cutting a piece of cake if the desserts taste horrible it doesn't matter whether it has been cut into 10 pieces or 20 pieces. So in other words if you're cutting up the cake it is what it is you can make as many slices as you want you're not really changing the underlying essence of it in any way. Some opponents of stock splits view the action as having the potential to attract the wrong crowd of investors. So notice if you're reducing the stock price some might say well yeah that's going to draw in more investors to some degree but those are going to be the people that are drawn on indicators that aren't underlying fundamental values and so those investors are saying well those aren't the people I'm really care to be interested because they're only going to be shifting short run prices where I'm on the long term game I'm not going to do anything that's not going to be done that's not going to increase the actual value of the company in the long term. So consider and this is the classic example Berkshire Hathaway's class A shares trading for hundreds of thousands of dollars had Warren Buffett split the stock many traders in the general public would be able to afford his company shares instead to maintain equity ownership as exclusive a company may want to intentionally not split its shares and I think Warren Buffett has kind of a theory of value looking for companies on a value basis really looking at the fundamentals of the company and so on and so forth so I would assume that part of his rationale is just that he's saying hey look I'm not going to do it if it doesn't affect the underlying value which is the whole basis of his investment strategy if it's just a superficial kind of thing on a stock split and it's trying to attract people based on superficial things instead of underlying fundamentals then he's not interested in it right and you know so in any case last there are implications for intentionally reducing the company's share price public exchange such as the Nasdaq requires stock to trade at or above one dollar should a share price drop below one dollar for thirty consecutive days the company will be issued a compliance warning and will have one hundred and eighty days to regain compliance should the company stock price still not meet minimum pricing requirements the company risks being delisted so example of a stock split and in August 2020 Apple AAPL split its shares four for one right before the split each share was trading at around five hundred forty dollars after the split the price per share at the market open was one hundred and thirty five dollars approximately five hundred forty dollars divided by four and investor who own four one thousand shares of the stock pre-split would have own four four thousand shares post split Apple's outstanding shares increased from three point four billion to approximately thirteen point six billion while the market capitalization remains largely unchanged at two trillion dollars so a company may choose to split its stock as many times as it would like for instance Apple also split its stock seven for one in two thousand fourteen two for one in two thousand five two for one in two thousand two for one in nineteen eighty seven stock split versus reverse stock split a traditional stock split is also known as a forward stock split a reverse stock split is the opposite of a forward stock split a company carrying out a reverse stock split decreases the number of its outstanding shares and increases the share price proportionally so they can do the opposite as with a forward stock split the market value of the company after a reverse stock split remains the same so it's a similar kind of process the the underlying value has not has not changed but the number of shares outstanding in this point on the reverse has now decreased the company that takes this corporate action might do so if the share price have decreased to a level at which it runs the risk of being delisted from an exchange for not meeting the minimum price requirement for a listing so this is something that is usually a bad signal right so if you so you don't want to usually do this unless you had to do it possibly because you're in danger of being delisted or something like that and oftentimes the market will punish this kind of move because it may show weakness in the stock so certain mutual funds may not invest in stock prices priced below a present minimum per share a company might also opt for a reverse split to make its stock more appealing to investors who may perceive higher price shares as more valuable a reverse slash forward stock split is a split is a special stock split strategy used by companies to eliminate shareholders holding less than a certain number of shares a reverse slash forward stock split consists of a reverse stock split followed by a forward stock split the reverse split reduces the overall number of shares a shareholder owns causing some shareholders who own less than the minimum required by the split to be cashed out so this is kind of a kind of a sneaky way to say hey look with all the smaller shareholders aren't aren't what we want in terms of our holding so they're going to basically cash them out and using this strategy so the forward stock split then increases the number of shares owned by the remaining shareholders what happens if I own shares that undergo a stock split when a stock split a credit shareholders of record with additional shares which are reduced in price in a comparable manner for instance in a typical two-for-one stock split if you owned 100 shares that were trading at $50 just before the split you would then own 200 shares at $25 each so you're in the same position but with two shares would be the general idea instead of one your broker would handle this automatically so there's nothing you need to do so hopefully this will be handled on the broker side it does cause a little bit of confusion when you sell the stocks because then you got to figure out what the cost is which hopefully the broker can can figure out but if you've been holding on to stocks for some time that have been splinted split multiple times it could be a little bit confusing but in any case will the stock split affect my taxes no the receipt of the additional shares will not result in taxable income under existing U.S. law so in other words it's not a taxable event because you didn't sell the shares at that point in time it's just the stock split so when you sell the shares that's when you usually realize the gains and or losses and have a tax impact possibly at that point so the tax basis of each share owned after the stock split will be half of what it was before the split are stock splits good or bad stock splits are generally done when the stock price of a company has risen so high that it might become an impediment to new investors therefore a split is often the result of growth or the prospect of future growth and it's a positive signal moreover the price of a stock that has just split may see the uptick if the lower nominal share price attracts new investors so does the stock split make the company more or less valuable stock splits neither add nor subtract fundamental value no impact on the balance sheet in other words other than superficial impact on the number of shares the split increases the number of shares outstanding but the company's overall value does not change immediately following the split the share price will proportionately adjust downward to reflect the company's market capitalization if a company pays dividends the dividend per share will be adjusted accordingly so you might think well what if the dividends will go on out well if you just going to get the same adjustment same amount of dividends now applied to the two stocks overall dividend payments the same splits are also non-dilutive meaning that shareholders will remain the same voting rights they have beforehand in other words if I had one stock before and now I have two stocks I still have the same percentage ownership in the company and therefore it should dilute my voting potential which might be more of important to a shareholder that owns like 10% or above for example and so if they did a split and it was to to dilute take them under 10% that would be but that's not what happens right they would be having a split and now they have twice as many shares but still the same percentage of the shares keeping their voting power intact in essence can a stock split be anything other than a two for one so while a two for one stock split is the most common any other ratio may be used so long as it is approved by the company's board of directors and in some cases by shareholders split ratios may be for instance three for one ten for one three for two etc and the last case if you owned 100 shares you would receive 50 additional shares post split