Stock Split Definition

What is a stock split, what types exist, and what does 1:10 or 10:1 mean in this context? Continue reading to learn more about how to interpret stock split announcements correctly.

What is a Stock Split?

With a stock split, a company either increases the number of outstanding shares by distributing more shares to current shareholders (this is called a forward split) or reduces the number of shares (aka. reverse split).

It does not change the company’s market capitalization or the proportional ownership stake of shareholders. Stock splits are typically done to keep the share price in an optimal trading range and improve liquidity.

Types of Stock Splits

Forward splits and reverse splits are the two main types of stock splits.

A forward split increases the number of outstanding shares held by investors (e.g., 2-for-1, 3-for-1, 10:1). So, for one share, you’ll get more shares. But at the same time, the price per share gets reduced by the ratio.

In contrast, a reverse split decreases the number of shares and raises the stock price proportionally (e.g., 1-for-10 reverse split). That means the number of stocks in your portfolio is reduced while the price per share increases.

In both cases, the overall value in the portfolio remains equal.

Stock Split Ratios

Companies can implement stock splits at various ratios like 2-for-1, 3-for-2, or higher multiples. For example, in a 10-for-1 forward split, each existing shareholder receives 9 additional shares for every 1 share they currently own, thereby increasing their total shares tenfold while the price per share is adjusted downward proportionally.

Effects of a Stock Split

A stock split has no direct effect on a company’s market capitalization or the proportional value of each investor’s holdings. However, the increased affordability and liquidity from a forward split can drive up demand and perception, potentially raising the stock price over time. Reverse splits are sometimes used to boost a low stock price above exchange listing requirements.

Example: If a company’s share price falls below $1, then it is at risk of getting delisted from Nasdaq after a certain time traded below that threshold.

A reverse stock split can then catapult the stock price above the $1 level again. Still, just being above that level does not mean that the company is more likely to make profits again.

Stock Split Adjustments for Options

When a stock split occurs, corresponding adjustments are made to existing options contracts to maintain their fair monetary value.

The strike prices are adjusted by the split ratio, and the number of shares per contract is adjusted inversely to offset the share price change. This adjustment keeps the premium cost neutral for both call and put options.

Reasons for Stock Splits

Companies commonly execute stock splits to make shares more affordable and liquid for smaller retail investors.

Example: If a stock is trading at $200 per share, a 2-for-1 split would double the number of outstanding shares while reducing the price to $100, potentially attracting more buyers.

Stock splits signal optimism from management about future growth potential. Investors prefer to see a forward split, where they hold a higher number of shares after the stock split in their portfolio, with stock prices at a more attractive price level.

Price-sensitive investors might tend to stay away from investments in stocks with stock prices above $1,000. A stock split of 10:1 would bring the stock price down to $100, and the investor who already has shares would then have 10 times the shares he had before the stock split.

In addition, investors who shied away from investing in a $1,000 stock now might think that it is a more attractive investment to buy it at $100 (even if, in reality, nothing really changed for the company value just because of the split).

Alexander Voigt, CEO
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Alexander Voigt is the founder of DayTradingZ, was a regular contributor to Benzinga and has been featured and quoted on leading financial websites such as Investors.com, Capital.com, Business Insider and Forbes.