A stock split is a term that has recently been all over the investing world. Why? Well, because one of the largest companies in the world — Apple Inc. (NASDAQ: AAPL) — has recently announced a fresh stock split. So although companies on the ASX aren’t as prolific with stock splits as our friends over in the United States, understanding how these splits work is still a valuable piece of investor information that I think everyone should have their head around.
What is a stock split?
A stock split is… well, it’s all in the name. It refers to the process of a company deciding to ‘divide’ existing shares into smaller parts. Apple announced last week that it would be undergoing a 4-for-1 stock split soon. This means that an existing Apple share will be split into 4 parts, each worth a quarter of what the ‘unsplit’ shares are valued at.
To be very clear, this has no impact on the value of a person’s Apple holdings. Say I have 2 Apple shares worth US$445 each before the split takes place. After the split, I will have 8 Apple shares worth approximately US$111.25 each. My overall Apple position has not changed one iota. It’s really just a game of arithmetic at the end of the day.
Why do companies do it?
Because a stock split has no real impact on any current or future investors, it can be hard to understand why a company would want to split their shares. The usual explanation is that it ‘levels the playing field’ of potential new investors to the company.
If a company has a $5 share price, virtually anyone who can buy shares in the first place is able to invest in said company. But take a company like Amazon.com Inc. (NASDAQ: AMZN). Its shares are presently valued at more than US$3,000 (A$4,193) each. Many newer retail investors simply don’t have that kind of capital to sink into one company. One famous example is Warren Buffett’s Berkshire Hathaway Inc. (NYSE: BRK.A)(NYSE: BRK.B). It has never, in its long history, split its A-class shares. As a result, one single BRK.A share will set you back around US$315,000 today.
The logic goes that those potential investors that might not have wanted to buy Apple for US$450 might be more inclined to do so if Apple shares were closer to US$110. And more buying pressure of any kind is good news for existing Apple shareholders.
But in reality, I think stock splits make for good public relations and not much else. Something to remember when you next hear the term ‘stock split’!