Here’s what happens. A stock currently priced at $80 per share, announces a 2-for-1 stock split. If you own 100 shares before the split worth $8,000, you will own 200 shares worth $8,000 after the split.
The market automatically marks down the price of the stock by the divisor of the split. The $80 per share price becomes $40 per share.
There are other splits such as 3-for-1 and 3-for-2. However 2-for-1 seems the most common.
In terms of what your holdings are worth, nothing changes. In terms of what the company is worth, nothing changes. So, why do it?
- Perception – Some companies worry when the per share price gets too high that it will scare off some investors, especially small investors. Splitting the stock brings the per share price down to a reasonable level.
- Liquidity – If a stock’s price rises into the hundreds of dollars per share, it may reduce the trading volume. Increasing the number of outstanding shares at a lower per share price aids liquidity.
it’s important for a firm to keep its share price in an optimal range to make it affordable for as many investors as possible. (The larger a firm’s potential investor base, the greater value it is likely to attain in the market.) In addition, stock splits are often a positive signal from management because firms only tend to split their shares when they believe their fundamental corporate prospects are strong. As a result, studies have shown that stocks tend to outperform the market immediately after a split.