A stock split is quite a common phenomenon in markets, and occurs on various exchanges around the world and at various times. This guide will help you understand what stock splits are, how they impact your stock positions, and how eToro handles them on the platform.
What is a Stock Split?
A stock split is a pretty self-explanatory term. A company splits its individual shares into smaller pieces at a certain split ratio. For example, if a company announces a five-for-one stock split, and each current company stock is valued at $400, then the share price would drop to a fifth of that, or $80, after the split. During such an event, each shareholder’s current number of stocks is multiplied, based on the split ratio.
Why do Stocks Split?
There are several reasons why a company would decide on a stock split. Here are a few points to know about the reasons for stocks splitting:
- Attracting retail investors: Some investors would rather not invest in certain stocks if the individual share price is too high. Carrying out a split would lower the price of circulating shares, thus, enabling more investors to buy stocks. However, while many institutional investors still exclusively buy whole shares, many retail investors opt to buy fractional shares through innovative trading and investing platforms, such as eToro.
- Greater liquidity: The larger the number of shares that exist in the market, the greater the potential for liquidity. More shares can mean more transactions and more money changing hands.
- Psychological pricing: Analysts often say a certain stock is “overvalued,” meaning, its current price represents the sentiment in the market, rather than its actual worth. Splitting a stock reduces its price significantly, thereby providing the psychological effect that the share price is more realistic.
- When does a stock split? There is no fixed formula. Some companies split their stock price every few years, providing they show constant growth, while others refuse to split their shares, no matter how high the price of each individual stock climbs. When it comes to timing, companies will usually allow at least a few weeks between the announcement and the actual split.
How many Times can a Stock Split?
Theoretically, infinitely. Companies can split their stocks as many times as they wish. For example, between 1987–2003, tech giant Microsoft split its stock nine times. However, since there is paperwork and bureaucracy involved, companies will most likely only split stocks when they feel it is a good and timely decision for their business.
Share Prices and Indices
Sometimes a stock split can influence an entire index. For example, the weighting within the DJ30 index is calculated based on share price. This means that if a stock splits, its proportional part of the index will diminish significantly. For example, Apple’s 2020 stock split changed it from being the top weighted stock within the DJ30 all the way down to number 16.
How does a Stock Split Impact Share Price?
Naturally, there is no guaranteed outcome for a stock split. The value of each individual share is split, but the overall market cap of the company stays the same. However, throughout history, stock splits have usually been in favour of the splitting company, at least in the short term.
According to Bespoke Investment Group, between 2015–2020, the average price changes for stocks of companies that announced splits has been an additional 2.3% from the time the split was announced until the time it took place. Moreover, nearly 70% of these stocks outperformed the S&P 500 index during that time. While the average stock also fell 0.3% immediately after the split, over the following year, these companies gained an average of 9.8%.
Despite the above, it is important to note that there are numerous factors that can impact a stock’s price, and the decision to split a stock may coincide with other factors that can potentially drive a stock’s price higher. Therefore, as positive as this past performance is, it may not be a reliable indicator.
What is a Reverse Stock Split?
A reverse stock split is the opposite of a stock split. In a reverse split, the company consolidates stocks, reducing the overall number of stocks. For example, if a certain company announces a four-for-one reverse split, and each share is currently worth $50, the new share price would be $200 and a shareholder that has eight shares would now have two.
How does a Reverse Stock Split Affect Traders and Investors?
Unlike a normal stock split, in which the number of shares is simply multiplied by the split ratio, a reverse split could leave a shareholder with fractional shares. For example, if a certain shareholder has five shares, and the reverse stock split is four-for-one, they will end up with 1.25 shares. In this case, most companies would simply liquidate the fractional share and give the shareholders the difference in cash. However, on eToro, if such an event were to occur, positions would not be affected, since eToro enables fractional stock ownership.
How do Stock Splits work on eToro?
eToro is home to numerous traders and investors who use the platform to invest in stocks with 0% commission. Since it has such a large stock offering, eToro is no stranger to stock splits, and has handled them in the past.
When such a market event occurs, eToro creates a seamless process of applying the split ratio to all related figures. The change will be applied to the total unit count and the average or current price. However, the value of each position will not change.
If a reverse stock split occurs, this means that a position that was previously composed entirely of whole shares could potentially now have fractional shares. However, the overall value of the position will not change due to the split.
eToro may communicate with its users ahead of time, letting them know of an impending split and if any action is required on their part — although it is highly unlikely that there will be.
This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to buy or sell, any financial instruments. This material has been prepared without having regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past performance of a financial instrument, index or a packaged investment product are not, and should not be taken as a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.