Disadvantages of Stock Splits | Stock Split Explained
There are a couple of types of stock splits, and each has its pros and cons.
The disadvantages of stock split depend on what kind of split the company has and the overall perception of the company’s future growth.
Key Takeaways
A stock split is a corporate action in which a company increases the number of shares outstanding by dividing each existing share into multiple shares, with the intention of making the stock more affordable and accessible to investors.
While stock splits can have some benefits, such as increasing liquidity and improving marketability, they also have several potential disadvantages that investors should be aware of.
One of the primary disadvantages of a stock split is that it does not fundamentally change the value of the company or its underlying assets. Instead, it simply increases the number of shares outstanding and reduces the price per share, which can lead to increased volatility and trading activity.
What is the Stock Split Meaning?
A stock split is when corporate decides to increase the number of outstanding shares by issuing more shares to stockholders.
Even though more shares are given to shareholders, the total value remains the same since the share price will also drop.
The best way to visualize a stock split is to think of it as cutting extra slices into a pizza. There are more slices, but the pizza size is the same.
What is the Point of a Stock Split?
There are a couple of reasons why a company may decide to have a stock split. The first reason is that psychologically a lower-priced stock looks more affordable to retail investors.
Additionally, many retail investors may not be able to purchase fractional shares, so a $1,000 stock may not be accessible to all investors. However, if the company has a stock split and the share price drops to $200 per share, more retail investors can invest in the company.
Types of Stock Splits
There are two main types of stock splits. There is the traditional stock split and the reverse stock split. It is necessary to understand both in case one of the stocks you invest in were to have a stock split.
Traditional Stock Split
A traditional stock split is when a company increases the number of outstanding shares to decrease its share price.
Reverse Stock Split Explained
A reverse stock split is when a company reduces its number of outstanding shares. The best way to visualize this is if you took a pizza with 24 slices and combined them, so there are only 12 slices. The total size of the pizza remains the same, but each piece is worth more.
Generally, reverse stock splits only happen when a stock goes so low the share price needs to be higher. If this happens, it is not the greatest sign of a well-performing company.
Pros and Cons of Stock Splits
Disadvantages of Stock Split
Stock splits cost money
The company will often hire a bank to facilitate the stock split and pay a fee.
Stock splits don’t attract the right type of investor
Companies want quality investors to buy their stocks that plan to hold them long-term.
Stock splits don’t change the company’s fundamentals
When a stock splits, the price per share goes lower, but it doesn’t change anything about the company. A lower share price doesn’t mean the stock is a better deal.
Advantages of Stock Split
Stock is more affordable
When a stock split occurs, it will make the share price lower and allow more people to buy and sell the company actively.
Increased liquidity
Since more people will be trading the stock, liquidity will increase, making getting in and out of the stock more efficient.
Management likely bullish on future growth
Companies with stock splits are generally bullish on future growth because they are okay with their lower stock price. If the company is ok with people perceiving its stock price lower, they must believe that people will buy it and drive it higher.
What Happens When a Stock Splits?
When a stock splits, each share will have a lower price, due to the increased amount of shares. The fundamentals of the company do not change, but shares will be cheaper for investors to purchase.
If a stock goes through a reverse split, the share price will be increased. This is common when a stock drops below the listing requirement of $1 for the Nasdaq.
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