What Is a Stock Split (& How Does It Impact Investors?)

If you were scrolling through FinTwit recently, you may have encountered news about an impending stock split. This type of corporate action impacts the share price of a public company's stock.

Here's how to decode an upcoming stock split—and whether you should act on your investment.

Stock splits, defined

A stock split occurs when a public company increases its total number of outstanding (sold) shares and decreases the price per stock at the same rate.

Each investor's position keeps the same overall value, but the number of shares in the position increases while the stock's price lowers.

This corporate action generally requires shareholder approval.

Stock split ratios: What they mean

Stock split ratios refer to the proportion that stocks split. For example, a 4-to-1 (or 4:1) stock split means that a person with 1 share now has 4 shares, and each of those shares are now worth one-quarter of the previous value.

In a 3-to-1 stock split, a person with 1 share now has 3 shares, and each of those shares are now worth one-third of the previous value.

Why stock splits happen

Companies split high-priced stocks for two key reasons:

1. Executives want more investors to find the stock accessible. Retail investors may be put off by a stock with a $2,000 price tag but be interested in a $500 stock.

2. Executives want to increase liquidity. By increasing the number of outstanding shares, company employees and institutional investors can sell portions of their investment more easily.

Performing a stock split may also create some buzz around a company, though this benefit is usually a secondary benefit.

Is a stock split good or bad?

A stock split generally signals that a company's stock is doing well—so well, in fact, that the price is too high.

Investors usually get a warning ahead of time that a stock split is coming. This gives people time to load up their shares if they want before the stock split occurs. It won't change the overall value of the position, but positive sentiment around a stock can increase its value.

Stock splits aren't always hitting gold, though. As always, it depends on the circumstances surrounding the move and the motive behind it.

A reverse stock split is a different story. Reverse stock splits decrease the number of outstanding shares and increase the value of each stock proportionately. Companies aiming to increase their low-priced stock could be making up for bigger issues dragging the stock's price down.

Stock splits in the wild

Apple (NASDAQ:AAPL) and Tesla (NASDAQ:TSLA) both had stock splits in August 2020. Apple's stock has split five times since the company went public in 1980.

Summit State Bank (NASDAQ:SSBI) is a micro-cap company that's splitting its stock at an 11-to-10 ratio in late October 2021. According to a press release, "Each shareholder of the Bank will receive one additional share of stock for every ten shares owned on the record date of October 29, 2021."