The Motley Fool

What Is: A Share Split

When shares go up over a long period of time — as many do — it can create a problem for new investors that want to buy a slice of the better-performing companies.

Take the U.S. company Coca-Cola (NYSE: KO) as an extreme example. The company floated in 1919 at $40 (€29) a share. Thanks to the company’s growth and the appreciation of the shares, today each share would be worth around $8 million (€3 million). If the stock were trading at $8 million per share, then anyone wanting to invest less than $8 million in Coke, or invest anything other than a multiple of $8 million, just wouldn’t be able to do so.

But Coke’s shares are trading well under the $8 million mark these days. That’s because there have been numerous share splits at the company over the years.

To increase the marketability or liquidity of shares, and thus reduce the aforementioned „$8 million per share“ problem, companies implement a share split from time-to-time. The basic principle of a share split is that the company is cut into more slices. Importantly, shareholders remain holding proportionately the same amount of the company as they did before the split.

Is there a cut-off point as to when shares must be split? Surely they don’t have to reach Coke’s $8 million, do they?

No, there’s no official cut-off point.

How about a simple example?
StockSplit GmbH has one million shares in issue, and each share is worth €50. A 5:1 share split is declared.

Hold on. What’s this 5:1 business?
That’s the format for how companies refer to the splits. In this case, investors of StockSplit GmbH will have, after the split, five shares for every one they had before. It’s referred to as a „five for one split“.

There’s no obligation to perform 5:1 splits though. A company could do a 2:1, 3:1, or even a 10:1 split, for example.

You may continue…
Thanks. StockSplit GmbH undergoes a 5:1 share split at €50. So, an investor of StockSplit GmbH having had just one share worth €50 before the split, would have five shares worth €10 after the split.

Here’s the important point. The overall shareholding value hasn’t changed. It still remains at the €50 total.

And do you remember the one million shares in issue before the split? After the split, there will be five million StockSplit GmbH shares in issue. And just as the value of individual investor’s holding won’t change, so the value of the company won’t change either. All that has altered is it has allowed investors to buy the shares in €10 multiples, rather than in €50 multiples. It all makes for a little more liquidity in the StockSplit GmbH shares.

Does these share splits make any difference to the company at all?
No. Not a jot. Its prospects, profits and assets remain the same as before. The only things that will change are the „per share“ values that are reported, such as net asset value per share, earnings per share, and dividends per share. Historical records are restated to reflect the additional shares.

Some people think share splits can be beneficial for share prices. The theory is that the increased marketability of the shares leads to an increase in demand for them. This, in turn, pushes up the share price. There is little evidence for this though. Remember, the value of the shares is inherently related to the value of the underlying business — since a share split doesn’t change the value of the underlying business, the overall pie is still worth the same amount.

How will I know a share split has occurred?
The company will make an announcement to the stock market of a split proposal. If investors happen to miss the statement, they will usually subsequently find out by an alarming share price „decline“ in their portfolio.

If, one morning, you see that one of your shares has fallen by 75% or 80%, a share split may well be the reason. Either that or it’s issued a disastrous profit warning!

Can companies do a reverse split?
Yes. When their share price has fallen a lot, some companies will do a reverse split or share consolidation. They may issue 1 new share for every 20 old shares, for example. This is usually an attempt to restore some credibility, as there is a certain stigma associated with having a share price of just a few pennies.

One downside of a share consolidation is that the number of shares you hold may not divisible by 20 (or whatever ratio is used). You can’t have part of a share, so the number of new shares you get is usually rounded down to the nearest whole number. The difference, known as a fractional entitlement, is typically sold off for the benefit of the company although, in some circumstances, shareholders may receive the cash payment instead.