Stock Splits and Reverse Stock Splits
A __stock split__ is—go figure—splitting stock. One share becomes more than one.
In a two-for-one stock split, denoted 2:1, you simply take each fractional ownership in the firm (share) and turn it into two. Each share is then worth half as much. It's a lot like taking a pie that's cut into eight pieces and cutting each piece again so that you have 16 pieces. You end up with more, smaller slices of the same pie.
What effect do you suppose this will have on the value of existing shares?
Not so.
This would indicate that each share is still worth two-thirds of its former price. This would be the case for a 3:2 stock split.
That's right!
A 3:1 stock split will divide the value of one share into three. In fact, Disney did this back in 1998. Prior to that, Disney also had 4:1 stock splits in both 1986 and 1992. An investor who purchased 500 shares of Disney in 1985 would have had 24,000 shares if they were held until the turn of the century.
$$\displaystyle 500 \times \frac{4}{1} \times \frac{4}{1} \times \frac{3}{1} = 24{,}000 $$
With each stock split, the fractional ownership of Disney didn't change. The total value of the firm grew over time as the company grew and became more profitable, and the investors did therefore experience gains in the value of their investment over time. But the share of the firm owned by each stockholder didn't jump on any of those stock split dates.
No, it won't.
Splitting stock also splits the value of stock. Price per share won't remain the same.
The __price to earnings (P/E) ratio__ isn't on the list, but since this is the price per share divided by earnings per share, what do you think this stock split will do to the P/E?
Absolutely!
Cutting shares in half doesn't change any profitability measure any more than it changes fractional ownership. The P/E will also remain the same.
Stock splits can occur in many ways. A 2:1 stock split is most common, but 3:1 or 4:1 splits aren't rare. A 3:2 stock split turns every two shares into three, increasing the number of shares by 50% and dropping their value by one-third.
No.
Consider that price is on top of the P/E, and it's getting cut in half. It couldn't double.
Not quite.
While it's true that the price is getting cut in half, notice that earnings per share is also being cut in half.
Why do you think Citibank might choose to do this?
No.
It actually made the stock more expensive.
Exactly!
After the financial crisis, Citibank's share price dropped from USD 50 down to about USD 1. Then it stayed in the range of USD 1 to USD 5, and that makes it start looking like a "penny stock," and that doesn't look so good. So a reverse split is just another type of stock split in which a company is essentially adjusting share price with no real value changes.
Not quite.
There's no change in equity because of this.
As far as an investor is concerned, what seems like a 2:1 stock split?
No.
A 1:2 reverse split would seem like just the opposite; because it is.
Right.
A 100% stock dividend would create twice as many shares each worth half as much. It seems identical to a 2:1 stock split.
But is it? Not quite; the only difference is an accounting issue. A stock dividend moves retained earnings to investor paid-in capital, and a stock split doesn't. So the statement of owner's equity would look a little different. But the investor's experience would be largely the same.
Not really.
A cash dividend would leave the investor with more money and the same number of shares. A 2:1 stock split would do neither.
To summarize:
[[summary]]
The declaration of a 3:1 stock split, for example, would provide each holder of 100 shares of the firm's stock with 200 new shares. An investor who owned 100 shares yesterday would own 300 shares today. Meanwhile, the number of shares outstanding triples.
Here's a simplified example of a 2:1 stock split:
| | Before Stock Split | After Stock Split |
|---|-----|-----|
| Shares Outstanding | 4,000,000 | 8,000,000 |
| Earnings per Share (USD) | 0.72 | 0.36 |
| Stock Price (USD) | 21.80 | 10.90 |
| Market Capitalization (USD) | 87,200,000 | 87,200,000 |
There's also a __reverse stock split__, in which shares are essentially glued back together. Citibank did this in 2011 with a 1:10 reverse stock split. For every 10 shares an investor had before the reverse stock split, afterward there was just 1. Each was worth 10 times as much, of course, and nothing else really changed.
The price per share will remain the same
The price per share will drop by one-third
The price per share will drop by two-thirds
Nothing
Double it
Cut it in half
To reduce equity
To make the price look better
To make the stock more affordable
A 1:2 reverse split
A 100% stock dividend
A cash dividend equal to half of the original share price
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