A stock split or stock divide increases the number of

shares In financial markets, a share (sometimes referred to as stock or equity) is a unit of equity ownership in the capital stock of a corporation. It can refer to units of mutual funds, limited partnerships, and real estate investment trusts. Sha ...

in a

company A company, abbreviated as co., is a Legal personality, legal entity representing an association of legal people, whether Natural person, natural, Juridical person, juridical or a mixture of both, with a specific objective. Company members ...

. For example, after a 2-for-1 split, each investor will own double the number of shares, and each share will be worth half as much. A stock split causes a decrease of market price of individual shares, but does not change the total market capitalization of the company: stock dilution does not occur. A company may split its stock when the market price per share is so high that it becomes unwieldy when traded. One of the reasons is that a very high share price may deter small investors from buying the shares. Stock splits are usually initiated after a large run up in share price.

Effects

The main effect of stock splits is an increase in the

liquidity Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include: * Market liquidity In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can quic ...

of a stock: there are more buyers and sellers for 10 shares at $10 than 1 share at $100. Some companies avoid a stock split to obtain the opposite strategy: by refusing to split the stock and keeping the price high, they reduce trading volume.

Berkshire Hathaway Berkshire Hathaway Inc. () is an American multinational conglomerate holding company headquartered in Omaha, Nebraska. Originally a textile manufacturer, the company transitioned into a conglomerate starting in 1965 under the management of c ...

is a notable example of this. As of 2023, the company has never split its stock and trades at over US$500,000. One possible explanation for increased trading volume is confusion. If some investors are unable to recognize that a split stock should trade at a lower price than before the split, the result can be a temporary increase in demand and the share price. Others contend that the management of a company, by initiating a stock split, is implicitly signaling its confidence in the future prospects of the company. In a market where there is a high minimum number of shares, or a penalty for trading in so-called odd lots (a non multiple of some arbitrary number of shares), a reduced share price may attract more attention from small investors. Small investors such as these, however, will have negligible impact on the overall price.

Split ratios

Ratios of ''2-for-1'', ''3-for-1'', and ''3-for-2'' splits are the most common, but any ratio is possible. Splits of 4-for-3, 5-for-2, and 5-for-4 are used, though less frequently. Investors will sometimes receive cash payments in lieu of fractional shares. In the above examples ‘y-for-x’ Shows the number of shares before (x) and after (y). Other common reporting nomenclatures are ‘x-y’ and ‘stock dividend’ of -x. In the above ‘3-for-1’ example (or 1-3 and 2 share stock dividend) would mean a stockholder holding 100 shares (on record date) will receive 200 new shares after the split for those 100 shares.

Example

A company which has 100 issued shares priced at $50 per share, has a market capitalization of $5000 = 100 × $50. If the company splits its stock 2-for-1, there are now 200 shares of stock and each shareholder holds twice as many shares. The price of each share is adjusted to $25 = $5000 / 200. The market capitalization is 200 × $25 = $5000, the same as before the split.

Currency

The analog in

currency A currency is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general definition is that a currency is a ''system of money'' in common use within a specific envi ...

would be redenomination. This would be where a currency increases in value so that people have to use small fractions. Then a new unit (such as dollar) can be introduced, such that an old unit is equal to 10 (or some number) new units. An example is with the Australian currency. In 1966 the Australian pound was split into two

Australian dollar The Australian dollar (currency sign, sign: $; ISO 4217, code: AUD; also abbreviated A$ or sometimes AU$ to distinguish it from other dollar, dollar-denominated currencies; and also referred to as the dollar or Aussie dollar) is the official ...

Effect on historical charts

When a stock splits, many charts show it similarly to a

dividend A dividend is a distribution of profits by a corporation to its shareholders, after which the stock exchange decreases the price of the stock by the dividend to remove volatility. The market has no control over the stock price on open on the ex ...

payout and therefore do not show a dramatic dip in price. Taking the same example as above, a company with 100 shares of stock priced at $50 per share. The company splits its stock 2-for-1. There are now 200 shares of stock and each shareholder holds twice as many shares. The price of each share is adjusted to $25. As a result, when looking at a historical chart, one might expect to see the stock dropping from $50 to $25. To avoid these discontinuities, many charts use what is known as an adjusted share price; that is, they divide all closing prices before the split by the split ratio. Thus, when looking at the charts it will seem as if the price was always $25. Both the Yahoo! historical price charts and the Google historical price chartsGoogle Finance Historical Charts
/ref> show the adjusted close prices.

References