Overview of Stock Split
A stock split is when a company issues a variable amount of new shares proportionate to the existing shares. For example, a 2-for-1 stock split means every share of pre-split stock receives an additional share, resulting in a doubled amount of stock. The stock split ratio ultimately depends on each company’s Board of Directors, but typically lies in the range of 2-1 through 4-1. After a stock split, the stock price is lowered so that investors can purchase a full share of the post-split stock at a fraction of the original cost. Despite the reduction in stock price, the total value of post-split stock is the same as before.
A standard stock split won’t necessarily cause shareholder equity to increase or decrease. Since each existing shareholder’s proportion remains the same after the stock split, the sum of the proportions will still equal 1. This suggests that despite stock splits, the total market capitalization of the company won’t change, as long as its share price remains the same. Thus, equity per share may be decreasing but the overall equity won’t be affected.
How Does a Stock Split Impact the Market?
The actual stock split won’t impact the underlying fundamentals of the company, however, it can lead to a subsequent increase in liquidity in the market. Because of the stock’s decreased price point, more retail investors may be encouraged to purchase the stock and liquidity may potentially increase. This tendency is typically more pronounced with large stock splits. While more investment in a certain stock may potentially lead to an increase in the market’s share price, it’s important to note that a stock split isn’t a guarantee of higher returns in the near future.
What Happens to GE Stock When Company Splits?
GE recently announced a 4-1 stock split, which will be effective on August 31. According to CEO Larry Culp, GE’s split was partially motivated by the fact that “[GE] shares have become undervalued in the current market.” By dividing the number of outstanding shares by four, each share should theoretically become more attractive to investors. Additionally, a 4-1 stock split arguably exudes a sense of confidence from GE’s Board of Directors. It signals that the company trust in the long-term growth of the stock, despite recent negative news about the company.
Despite the potential benefits of a split, some investors doubt GE’s stock will experience a significant bump from this split. Historically, GE’s stock price often jumps slightly on the announcement of a split, before dropping back down to the original price range. Furthermore, investors’ focus is mainly on coming off of negative trend and slowly returning to a positive trend. Since a stock split alone can’t solve GE’s issues, investor focus remains on the underlying fundamentals of the company, such as its cash flow, profitability, and competitive edge.
Companies can also raise their stock prices by increasing investor confidence in the company through dividend payouts, buybacks, and share repurchases. Divided payouts are a surefire way to attract investors, since it promises them a set amount of reimbursement for each share. Additionally, when companies use extra cash to purchase their own stocks, the stock price increases since the demand for shares causes supply to drop.
Another potential strategy is a reverse split. Much like a stock split, a reverse stock split is when a company consolidates shares into fewer. An example would be a 1-for-2 split, where two shares consolidate into one share. However, unlike a normal stock split, reverse splits actually increase the stock price. By consolidating shares, the company reduces its public float, thereby increasing the stock price per share. This is usually done to protect a company from a delisting due to its low stock price, so that it can remain on a stock exchange.
Pros and Cons of Stock Splits
The primary benefit of stock splits for the company is the potential for increased liquidity, since it may bring in more retail investors due to the low price. Another potential upside is the confidence the Board of Directors appears to have in the company’s future. On the downside, however, a stock split is viewed by some as a symbolic move to temporarily boost stock prices, rather than a attempt to improve the company’s fundamentals. As a result, some investors may misinterpret a stock split as a sign that the company is in trouble, rather than that it is recovering.
Should Investors Consider Investing in a Splitting Company?
Investors should consider all possible implications of investing in a splitting company. Generally, the stock split won’t change the fundamentals in the near-term, however, it is wise to analyze the underlying health of the company and its long-term prospects for success. In addition, investors should consider the amount of risk versus the potential rewards of investing in a splitting company. If a company shows good prospects for the long-term, but the risk is slightly higher, investors should weigh their options in order to find the best investment strategy.
Impact of Legislation and Regulations on Stock Splits
Securities laws sometimes restrict the frequencies in which companies can issue stock splits. In some countries, a company may only be able to issue one stock split per year. Furthermore, some laws dictate if and how stock splits are reported. Misreporting stock splits can lead to legal troubles with certain regulatory agencies. Additionally, companies must sometimes file applications with governmental bodies before they can execute stock splits. In the United States, the SEC typically reviews filings before they are approved. Therefore, companies should be well-versed in the relevant laws and regulations.
The Future of Stock Splits
Stock splits have gained traction as a popular tactic to potentially increase liquidity and shareholder value. Depending on the company, stock splits can both reassure investors of the company’s health and attract new investors in search of lower stocks prices. However, investors should always do their due diligence to deeply assess a company’s fundamental health before investing. With the right research and information, stock splits may be a way to potentially increase shareholder value.
