Episode 87: Stock Splits 2.0

Transcript

Hello and welcome to the Balanced Wealth Podcast. My name is Jarrett Topel. Today, I am going to talk a bit about something that is getting a lot of news coverage these days, which is stock splits.

As you have likely heard, wall street’s latest darling stock, Nvidia, just did a 10-1 stock split. Being that Nvidia is so popular these days, this split is generating lot of interest in the topic of stock splits, and in the stock itself, so I thought now would be a good time to explain what they are, and what they are not.

First, let’s define what a stock split is. A stock split occurs when a company increases the number of its outstanding shares by issuing more shares to current shareholders. This action reduces the price of each share without changing the overall market value of the company. The important thing to know here, is that there is no real economic or financial value provided to shareholders when a stock split occurs. It is purely an accounting and perception thing.

A good way to understand this is, is. let’s say you have a hundred dollar bill. You go to the bank and give the teller your 100 bill, and in return, they give you 10 ten dollar bills. Either way, you have 100 dollars. There is no economic change or benefit from this transaction.

So, the obvious question is, if there is no economic benefit, why would a company bother? There are several reason a company may split its stock, but the main one is to increase the liquidity of its shares. By reducing the price per share, a stock split makes the shares more affordable to a broader range of investors. This can increase trading activity and liquidity.

When Nvidia was trading at over $1,000 per share, smaller investors have a hard time buying the stock. When the share prices is $100, they are much more likely to buy the stock. Agan, the stock is no more valuable than it was the day before, but it is more accessible to the average investor.

It is also important to know, that companies can, and often do, the opposite of a stock split, which is called a reverse stock split. In a reverse stock split, a company reduces the number of its outstanding shares, which increases the price per share. Once again, the overall market value of the company remains the same. Now, you’re taking 10 ten dollar bills to the bank and getting 1 one hundred dollar bill in return.

There are several reasons a company would do a reverse stock split. One reason is, to be in compliance with stock exchange requirements. Stock exchanges, such as the New York Stock Exchange or the NASDAQ often have minimum price requirements for listed stocks. A reverse split can help a company avoid being delisted from the exchange by boosting its share price above the minimum threshold to be traded on their exchange.

Another reason a company may do a reverse split is to attract institutional investors. Higher share prices can be more attractive to institutional investors who may have policies against buying low-priced stocks.

One final reason for a reverse stock split is to simply improve investors perception of a stock. A higher stock price can improve the perception of the company, making it appear more stable or financially sound.

In reality, as we have learned, it is really no more sound after the reverse split. But, sometimes, perception matters more than reality.

Disclosure

The opinions expressed in this program are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security. It is only intended to provide education about the financial industry. This program should not be construed as Financial, Legal or Estate Planning advice. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. always please remember, investing involves risk and possible loss of principal capital; please seek advice from a licensed professional.