Everything You Need to Know About Stock Splits (and Reverse Stock Splits)
In the nearly 30 years since Amazon started as a humble online bookstore, it has infiltrated almost every aspect of our lives. Now it’s a retailer, a grocery store, a media streamer, a movie production company, a cloud computing company, a major employer, and pretty much everything else. All of this expansion resulted in a market capitalization (the value of all of the company’s shares) of around $ 1.6 trillion , making Amazon the fifth most valuable company in the world (behind Apple, Saudi Arabian Oil, Microsoft and Google). That’s a lot of money, and if you bought Amazon stock twenty years ago, you’re a very happy (and fairly rich) person now.
That’s why Amazon’s recent announcement of a 20-to-1 stock split made headlines. If you’re one of those people whose knowledge of stocks and the stock market begins and ends with “it’s complicated” and the current, largely cryptic meaning of your 401k fund, you may be wondering why this made headlines. Why should anyone care, and what does a “stock split” even mean?
The difference between a stock split and a reverse stock split
Stock splits are actually a pretty simple concept. When a company splits its shares, it increases the number of shares, reducing the value of each individual share by a proportional amount. If your company has been split into ten shares worth $1 each, you can split it into 20 shares worth $0.50 each. The total aggregate value of the shares doesn’t change, it just creates more of them; if you previously had two shares worth $2, you now own four shares that are still worth $2.
A reverse stock split is the same as the reverse: a company reduces the number of its shares, increasing the individual value of each share without changing the overall value of the company. So if you have 20 shares of $0.50 each and you divide them back by 10, each share will be worth $1.
Typically, stock splits occur in relatively small proportions – the most common are 2 for 1 and 3 for 1. This is one of the reasons Amazon’s 20 to 1 stock made headlines – it is unusually aggressive. He also combines the move with a $10 billion share buyback, which will boost the value of the new shares slightly.
Why split shares?
Companies will split their shares when the share price gets too high. Investors prefer to buy shares in packages or “lots” of 100 shares. If individual shares become too expensive, small investors simply cannot afford to buy them. Amazon is a great example: its shares have been around $3,000 for a while now , which is pretty damn expensive. A standard purchase of 100 lots will set you back $300,000 plus fees, which is simply out of reach for many investors. Once the 20-to-1 split goes into effect this summer, each share will be worth around $150 (depending on the actual valuation when the time comes). This suddenly makes a lot of 100 shares more affordable at $15,000.
This could make stocks more attractive to stock market indices such as the Dow Jones Industrial Average, which uses 30 “famous” companies to track the health of the stock market as a whole. Since the Dow is price-weighted (meaning that the more expensive its stock, the more impact it has on the direction of the index), Amazon won’t be included at a stock price of $3,000, but at a price of $150 it is a candidate. The share split also makes the shares more liquid, which means they are easier to cash out, which also makes them more attractive to investors. After all, if your stock is so expensive that you can’t easily or quickly sell it when you need real money, it’s not really as useful an asset as you’d like.
The share split would also make it easier for Amazon to grant stock options to its employees. The sky-high share price makes modest grants in the $5,000 to $10,000 range difficult. The lower share price provides more flexibility.
Reverse stock splits, again, are used to achieve the opposite effect: if a company feels that its shares are getting too cheap (for example, at risk of delisting), a reverse stock split instantly increases the value of individual shares. There is also a maneuver called a reverse/forward stock split, in which a company first performs a reverse split of its shares, which forces some shareholders with very small positions to sell their shares, and then performs a standard stock split to return to the previous share price, increasing it. shares held by other shareholders. This is a way to force consolidation.
Stock splits in either direction are just simple management techniques: nobody really loses or gains anything at the moment, but how stocks are perceived and handled is changing in the future. Is this a good time to buy Amazon stock? Possibly, but this is a question for your broker.