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What is a stock split?

Ever wondered what a stock split does to your portfolio?

A stock split is a process whereby a company essentially multiplies the total number of shares. The main reason for doing so is to increase liquidity and attract new investors by lowering the share price without affecting other important stock-related metrics. Common stock split ratios include 2-for-1, 3-for-1, and 4-for-1.

So, how does a stock split work?

A stock split is essentially what the name implies. It involves the company splitting the stock into multiple shares. In the case of a 2-for-1 stock split, anyone who owns a single share in that company would subsequently own two after the process is complete. The same goes for 3-for-1, 4-for-1, and beyond. The former would be split into three shares, the next four, and so on.

So does the price of the shares remain the same and investors receive shares for free? That’s not quite how it works, though it would appear that way. What happens with a stock split is the company announces how many it will multiply the shares by. The share price is then altered to reflect the new pricing. Those already with shares will see their holdings multiply accordingly, but the overall market value will remain the same.

Take a 2-for-1 as an example. A company you hold shares in announces the stock split. It’s worth £100 at the time of announcing. You have 100 shares in the said company, worth £10,000. After the stock is split, you’ll then have 200 shares, worth £50 each, totalling £10,000. Your portfolio is unaffected, that is until the stock starts to climb again.

Why would a company want to split shares?

The primary reasons a company may want to split its stock is to increase liquidity and become more appealing to investors who may not have enough money to invest in the company at a higher price. Investing is a numbers game, but it still taps into human psychology whereby a stock priced at £50 is more appealing on the offset than one at £200, which is why a company may want to split its shares and attract new investors.

Ask yourself this: would you prefer to purchase 50 shares of a £10 stock or 5 shares of a £100 stock? Stock splits don’t add any real value to investors who already hold shares and the process of splitting does not add anything to the market capitalisation since we’re multiplying the shares and dividing the share price so everything evens out.

Should you buy before or after a stock split?

The simple answer is: it doesn’t really matter. If you purchase 10 shares of a £100 stock before a 2-for1 split, it’ll be worth the same as 20 shares at £50. The only difference between the two figures is the number of shares held. The same goes for dividend-paying stocks. Your 20 shares will earn you the same as the previous 10 shares since the dividend payment will also be adjusted.

If the share price of of the company that just performance a stock split goes up, it still won’t matter if you bought them prior or not. The 10 shares worth £100 each will net you the same gains post-split just as 20 shares worth £50 each would. It’s all for the face value. The best part about stock splits is you’ll have more shares to track using my awesome spreadsheet dividend tracker.

By Rich Edmonds

Rich creates content for the top Windows-focused publication, but by night he tries to make his money work for him and rambles far too much here.

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