Definition: An operation a corporation carries out to lower the price of each share of its stock while simultaneously granting shareholders a number of shares that will fully offset the drop in the share price.Example: On April 23, 2014, Apple announced a 7 for 1 stock split to be carried out on June 2, 2014. On that day, Apple shareholders who checked their brokerage accounts found that the share price of Apple was 1/7th of the prior business day’s closing price and that they now held 7 times the number of shares they held prior to the split.

Investeach explains: As we mentioned above, companies split their stock to make it feel more affordable. We say “feel” because it being cheaper doesn’t make it a more attractive investment. Because the number of shares outstanding goes up by the same factor that the price was dropped, the ratio of the new stock price to the profits being¬†achieved per share¬†is the same as before.

A second reason why companies split their stock is that causes more shares to be outstanding. These are more likely to be held by a wider group of owners and to be bought and sold more frequently. This improves the stock’s liquidity.

Companies may use any factor they wish to split their stock. Above, we used 4 for 1. More common is a 2 for 1 split. Finally, it is possible for companies to raise their stock price by doing a reverse stock split!

Riddle me this:

1. What are two reasons companies split their stock?
2. Why do we say that after a split the stock feels more affordable but isn’t any better an investment?
3. What ratio may companies use to split their stock?
4. What can companies with a very low stock price do to quickly bring the price up?

Related terms: Earnings per share, Liquidity, Reverse stock split, Shares outstanding.