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 Magnificent 7 stock, Amazon, when it announced a 20:1 split a few years back.

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 market capitalization doesn’t, at least in theory, 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. Sirius XM is a prime example of this in recent years with its 1:10 reverse split.

But if a company’s stock is performing so badly that it warrants a reverse stock split, this may be an indication the 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 have 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 and investors are usually quite content to continue accumulating vast amounts of stocks in this way.

Loyal investors will regularly trade these stocks’ splits because they often provide price spikes that lead to incremental gains.

Now, if you remember the illustration of the pizza above, you know the actual company valuation 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 share price 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 have 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 because each individual share is now worth $5.

If this company pays stock dividends, the dividend amount is also reduced due to the split. So, technically, there is 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 price has gone astronomical of late 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 climb in the share price.

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. Some Magnificent 7 stock splits making headlines in recent years have been Apple and Tesla.

Apple’s board oversaw a 4-for-1 split so four shares post-split were equal to one share pre-split. Tesla did a 5-for-1 split, meaning every share owned prior to the split resulted in 5 post-split.

Apple was trading around $500 per share before the split. Thereafter, investors who wanted to get in on the stock were able to do so for around $125 per share. 

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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.