Should I Buy A Stock Before It Splits?

Should I Buy A Stock Before It Splits? Investors and companies alike view stock splits as positive events. Look no further than the 5.5% pop in Amazon shares when it announced a 20:1 split after the market close on March 9.

When a board of directors declares a stock split, it’s a vote of confidence that the company’s share value will continue to increase.

Stock splits can increase affordability, meaning a broader range of investors may find the stock more attractive – thereby increasing demand.

On the face of it, a stock split shouldn’t really matter – regardless of the current economy. If you have a share of stock currently trading at $100 and it splits into four shares at $25 each, it’s the same as having an entire uncut pizza and cutting it into four slices – you still have the same pizza.

That said, many stocks have shown strong performance after a split. In other words, selling your shares of a stock prior to a split isn’t always the best decision – unless, of course, you’re not well-positioned to continue holding the stock.

So, what exactly is a stock split? And why do companies split their stocks? Well, it’s all a part of trading basics.

What Is A Stock Split?

A stock split is all about affordability for shareholders – at face value. It maintains a company’s current value yet divides existing shares, making them smaller and less expensive.

For example, when Tesla rose about $2,000 per share and Apple above $500 per share, management teams at both companies decided to split their stocks: 5:1 and 4:1 respectively.

If you owned 100 shares of AAPL prior to the split, you owned 400 shares afterwards. And in the case of Tesla you owned 500 shares post-split for every 100 shares held pre-split.

When Amazon announced its stock split in 2022, a shareholder owning 100 shares pre-split would own a whopping 2,000 shares post-split.

Reverse stock splits do the opposite by combining shares, effectively raising the price of a single share.

But at the very heart of stock splits is psychological reasoning. A company splits (or combines) its shares to make them less or more expensive. The company’s value on paper doesn’t change, but this move can improve the company’s liquidity – how fast and easy a trader can trade.

Why Do Companies Split Stocks?

Companies split stocks primarily to make them more affordable to future investors.

For instance, say a company has been around since the 1930s. Over those decades, the company has seen a lot of growth – their shares that sold for $40 each in 1940 could be worth thousands apiece today.

But again, a stock split merely adjusts the number of shares currently outstanding which, in turn, adjusts the price of each share. The overall company value doesn’t go up or down simply because the stock splits.

On the other hand, reverse stock splits could have other factors. For instance, say a company’s share prices have tanked – a reverse stock split increases the price per share, effectively making the company’s shares appear more valuable because they cost more.

But if a company’s stock is performing so badly that it warrants a reverse stock split, this is an indication this company might be a poor investment. Reverse splits shouldn’t be the only factor you examine when making an investment decision, but it should give you pause to do further research.

Is a Stock Split a Good Thing?

Stock splits are normally employed by companies that’ve seen substantial increases in share prices.

While outstanding shares increase and the stock’s price decreases, market cap and company value isn’t changed by the split alone.

That said, a stock split makes it easier for smaller investors to get a piece of the pie, which makes for greater marketability and market liquidity in the future.

When Amazon announced its split, management also announced a share buyback to the tune of $10 billion, which is a real tailwind for the share price as real capital flows create demand for shares.

Do Stocks Usually Go Up After a Split?

Stock splits tend to attract the attention of many investors, so lots of companies, like Tesla, use this tactic to generate a buzz and entice more investors to the company shares. Some companies perform stock splits on a regular basis. Investors are happy to continue accumulating vast amounts of stocks in this way.

Loyal investors will regularly trade these stocks’ splits because they often provide extra profit.

Now, if you remember the illustration of the pizza above, you know the actual stock value isn’t changed by the split – it’s the excitement from investors that cause the spike in stock price after a split announcement. Sometimes, the stock will rise even higher after the split.

Should I Buy a Stock Before It Splits?

Say you own 1,000 shares of a company worth $10 each. You’ve got an investment worth $10,000. If that company splits its stock – for instance, a 2-for-1 split – you now own 2,000 shares but your investment’s value is still $10,000. Each individual stock is now worth $5.

If this company pays stock dividends, the dividend amount is also reduced due to the split. So, technically, there’s no real advantage of buying shares either before or after the split.

There are also other things to take into account when contemplating which side of the split to trade on. For instance, if the company’s share prices have gone astronomical lately but you really want to own a piece of a certain company, you might wait until after the split to get a piece of the pizza pie.

On the other hand, splits are also considered positive from the standpoint of buying before the split. More investors might also want a share of the pie, thereby eventually leading to a raise in share prices.

How To Trade A Stock Split? Final Thoughts

It’s important to note, especially for new investors, that stock splits don’t make a company’s shares any better of a buy than prior to the split. Of course, the stock is then cheaper, but after a split the share of company ownership is less than pre-split. The most recent stock splits making headlines are Apple and Tesla.

Apple did a 4-for-1 split recently. Now, four shares are equal to one share pre-split. Tesla did a 5-for-1 split.

Apple was trading around $500 per share before the split. Now, investors who want to get in on the technological stock scene can do so in this giant for around $125 per share. The stock split also helped investors who want to get a piece of the electric car giant who may not have prior to the 5-for-1 split.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.