Finance Glossary

Understanding Stock Splits

Understanding Stock Splits

A stock split (or forward stock split) occurs when a company decides to divide existing shares into multiple shares. The split can occur in many different ratios, but the most common are 2-for-1 and 3-for-1. During a forward split, the number of shares increases by a specified multiple, while the total price of the shares remains the same. This means that market capitalization remains the same as well.

The main reason a company might split shares is in order to improve liquidity. A forward split usually occurs when the cost of an individual share becomes prohibitively high.  Smaller shares can be more easily purchased by an average investor. Trading becomes easier,  and the bid-ask spread may even lower. A stock split for a major company can also renew investor interest, improving stock performance.

Splits can also happen in reverse on occasion, meaning that the price of shares increases, while the number of shares decreases. A company may choose to do this so that the stock does not get delisted for being too low, or in order to give a positive appearance to investors.

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