A stock split or stock split is something that happens occasionally in the world of investing. But what exactly is it? Why does a company split shares? And do you benefit as an investor? In this article, we tell you more about it!
Alphabet, Google’s parent company, announced a so-called stock split last week. They say the reason they are doing this is to make the stock more attractive to investors with smaller stock markets. The stock is now running at $3,000. The stock price was $2752.88 on Tuesday around the announcement, and they want to split one share by 20, which will leave 1 Alphabet share at around $138. This means that if you own 1 share of Alphabet now, you will gain 19 after the split. Why do companies do this, and is it beneficial?
Stock split
What is it?
A stock split involves splitting a company’s shares into smaller pieces. This increases the number of shares outstanding in the market. Suppose a company had 1 million shares outstanding before and 2 million shares outstanding after the split, then it is a 2-for-1 stock split. So if you had one share, you will automatically have two after the split. Unfortunately, the price does not double with it!
Why do companies do a stock split?
Why do companies split their shares? One argument may be that they want this to make the stock more attractive to those with small pockets. This increases tradability and reduces the difference between bid and offer prices. And the psychological effect also weighs in: a stock seems cheaper. But it is not, because the “piece of the pie” is much smaller because there are more shares.
A stock split need not be done by a company. There is no law that says a split has to be done from a certain price. It is sometimes done by companies when the stock price has risen very hard. With a very high price, the stock is accessible to fewer investors than when the price of the stock is lower.
Sample….
Suppose a stock costs $2,000, but your investment budget is smaller, you are not so likely to buy that stock even though it may be a good stock. But after a 10-for-1 split, the stock for $200 is suddenly a lot more accessible to investors.
Does a stock become worth less after a split?
No, it’s simply going to be more. After Tesla did a split of its shares from 1 share for $2200 to 4 for $440, the price of shares skyrocketed. After a while, the stock price stood at $923, double a share after the split. Arithmetic: suppose before the Tesla split you had had 1 share a $2200, now you had 5 shares a $923. This may be because a cheaper stock increases demand among retail investors.
Is it smart to buy a stock that is going to split?
No, the value of the stock does not change. And the underlying value – the company – also remains the same. As an investor, you need to look beyond the price of a stock, because the price does not necessarily tell you everything about the intrinsic value of the company. Some people go wild on so-called penny stocks, which are stocks that are priced very low. It is very unwise to look only at the price of a stock and buy something based on that. Then you’re better off spending an evening at the casino.
Could it be easier?
Yes, much easier! Because including individual companies in your portfolio remains a gamble. Investing is and always will be a long-term, well-spread tactic. If you like to invest in tech stocks, you can also invest in an S&P 500 ETF. If you would like to own a piece of the pie of a high-priced stock, you can also invest fractionally, at BUX Zero for example.
Don’t be fooled that soon the price of 1 share will suddenly be much lower, but create a long-term investment strategy for yourself and stick to it!
