What Are Stock and Reverse Stock Splits?


       Stock splits are a lot less complicated than people think. A stock split is when a companies board of directors decides to increase the number of outstanding shares. The board of directors will decide what kind of split there is. The most common split is a 2 for 1 split. This means for every one share you own- you will now own two.

       For example, let's say you own 10 shares of ABC financial for $100 each- Then ABC financial decided to split the stock 2:1. So now instead of owning 10 shares, you own 20. But the shares are no longer worth $100. Instead, they are worth $50. So your equity of $1000 did not change, just the amount of shares you owned did.

       Although the 2 for 1 split is the most common, there have been bigger splits. For example, Berkshire Hathaway (BRK.B) had a 50:1 split in 2010. Meaning a single share was worth 1/50 of what it was before. But you owned 50 instead of 1.

But why would A company want to do this?

       Liquidity is one reason, the lower price makes and more attractive for smaller investors to buy and sell shares.

Stock splits on reputable companies generally result in a short-term boost for companies- the lower price is more attractive to smaller investors causing the supply and demand to fluctuate.  Another reason the stock may increase is because a split is an indication to the market that the stock is doing well. 

       On the flip side, companies sometimes go through a reverse stock split. A reverse stock split is not a good sign for your company. It's the exact opposite of the regular stock split.

       Let's say you have 100 shares at $1.00 each. The board of directors then decides to have a 1:2 split. The 1:2 split indicates that for every two shares you owned, you now own 1, but worth twice the value. The company doing these generally do it to avoid being delisted on the NYSE or Nasdaq.

       The higher price is also for the companies image, no company wants to be a penny stock.


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