Stock splits refer to the process where a company increases the number of its shares and reduces the price per share. This does not change the company’s total value but increases stock accessibility and sends positive signals to the market. Stock splits often occur when a company is performing well, which can positively impact the stock price.
1. Basic Concept of Stock Splits
A stock split is like dividing a pizza into more slices. For example, if a pizza initially divided into 4 slices is divided into 8 slices, the total amount of pizza remains the same, but the size of each slice decreases. Similarly, a stock split increases the number of shares but lowers the price per share. This allows investors to hold more shares.
2. Positive Signals of Stock Splits
Stock splits are often interpreted as positive signals. For example, Nvidia decided to split its stock after reporting outstanding quarterly results. This indicates that the company is doing well and is expected to continue performing well in the future. Companies announcing stock splits tend to outperform the S&P 500 index over the next 12 months.
3. Improved Accessibility and Attracting Investors
A high stock price can make it difficult for individual investors or employees to access the stock. To address this, many companies lower their stock price through a stock split, making it easier for more people to purchase the stock. For instance, Chipotle split its stock to make it more accessible to employees and various investors due to its high stock price.
4. Market Impact of Stock Splits
Stock splits can significantly impact specific market indices. For example, the Dow Jones Industrial Average is price-weighted, so a stock split can affect the index’s weighting. This can change the relative position of companies within the index.
5. Reverse Stock Splits: The Opposite Case
Conversely, if a company is underperforming, it may choose a reverse stock split. This process consolidates multiple shares into one to increase the stock price. For example, electric vehicle startup Canoo attempted to increase its stock price through a 23-to-1 reverse stock split after its share price fell below $1. However, such reverse splits can signal poor company performance.
Conclusion
Stock splits and reverse stock splits do not change the actual value of a company but send important signals to the market. A stock split is a positive signal that a company is doing well, while a reverse split can be interpreted as an attempt to overcome poor performance.