A GUIDE TO
STOCK SPLITS

A stock split is when a company increases the number of its outstanding shares by dividing its existing shares into multiple ones. The process can make shares more affordable to smaller investors and increase liquidity in the market.

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Stock splits are often used to make shares more affordable and increase liquidity in the market. 

Whether you’re new to investing or looking to deepen your understanding of market mechanics, this guide explains everything you need to know about stock splits. It covers how they work, their impact on indices and share prices, and what happens to your holdings during these corporate actions.

What is a Stock Split?

A stock split is a corporate action where a company divides its existing shares into multiple shares, increasing the total share count while proportionally reducing the price per share. The company’s overall market capitalisation, its value, remains unchanged.

The process of a stock split starts when the management of a firm decides to increase the total number of shares of a company which are in circulation by issuing new shares. 

Each existing shareholder receives new stock at a specified ratio. If the stock split ratio is 2:1 then a shareholder owning 100 shares would see the number of shares they hold increase to 200. 

As the underlying value of the company isn’t materially impacted during a stock split the price of each share on the exchange will halve. That means that the total value of the shareholders position will remain unchanged, they’ll just own more shares which each have a lower price.

The basic principles behind different stock split mechanics are outlined in the table below.

Split Ratio	Shares Before	Shares After	Illustrative Price Before	Illustrative Price After	Value Change (at split)
2-for-1	100	200	$100	$50	$0
3-for-1	100	300	$150	$50	$0
4-for-1	100	400	$200	$50	$0
5-for-1	100	500	$250	$50	$0

Market capitalisation remains constant during a split because while the number of shares increases, the price per share decreases proportionally.

Why do Stocks Split?

Companies split their shares primarily to improve accessibility and liquidity by reducing the nominal share price, making individual shares more affordable to a broader range of investors. 

The process does not affect the company’s fundamental value, instead it removes barriers to entry for those investors who want to use a smaller amount of their capital when buying shares in the company.

There are several key motivations for companies which decide to perform a stock split:

• Attracting retail investors: Some investors would rather not invest in certain stocks if the individual share price is too high. Carrying out a split would lower the price of circulating shares, thus, enabling more investors to buy stocks.
• Greater liquidity: The larger the number of shares that exist in the market, the greater the potential for liquidity. More shares in circulation can mean tighter bid-ask spreads and easier trading.
• Psychological appeal: For historical reasons, exchanges typically hold shares which trade within an expected price range. Having a share price outside that “normal” range can deter potential investors. 
• Risk management: Some retail investors could be exposed to concentration risk if a position in an “expensive” stock makes up a large proportion of their portfolio.

Case Study: Stock splits and concentration risk

• An investor has $1,000 to invest
• Company A’s shares trade at $1,000 each
• The investor can only afford to buy one share which would make up 100% of their portfolio, representing concentration risk
• Company A processes a 10-for-1 split
• As the fundamental prospects of the firm remain unchanged the share price falls to $100
• The same investor could buy one share and spread $900 of their capital across different investments.

When does a Stock Split?

Stock splits typically occur after a period of significant share price appreciation, with companies announcing the split date weeks or months in advance to allow markets and investors time to prepare.

The process follows a predictable sequence: 

1. The company’s board announces the split ratio to investors and regulatory authorities.
2. Their filing sets a record date – the date on which the details of eligible shareholders will be recorded.
3. It also sets an effective date – the date that the split will occur and when all shares will trade on a split-adjusted basis from the effective date forward.

How many times can a stock split?

There is no regulatory limit on how many times a company can split its stock, with some companies executing multiple splits over decades as their share prices appreciate.

A stock split is quite a common phenomenon in markets and occurs on various exchanges around the world and at various times. Each decision on whether to split or not depends on the company’s share price trajectory and management philosophy.

Case study: Different management approaches to stock splits

• Microsoft has split its shares nine times since the company was first publicly listed in 1986. Despite the huge growth in Microsoft’ s market capitalization the price of MSFT stock has remained below $600.
• Berkshire Hathaway’s Class A shares have famously never split, maintaining share prices in the hundreds of thousands of dollars as part of a deliberate strategy to encourage long-term, value-oriented investors rather than short-term speculators.

How do Stock Splits Affect Indices? 

Stock splits affect indices differently based on the indices weighting methodology. 

Price-weighted indices such as the Dow Jones Industrial Average Index (DJIA) experience significant rebalancing.

Market-cap-weighted indices such as the S&P 500 Index remain largely unaffected since the company’s total value doesn’t change.

The table below considers the way that stock splits affect different types of indices.

Index Type	What Drives Weighting	How a Split Can Change Weights	Example Indices
Price-weighted	Share price	Split reduces company’s weight proportionally	Dow Jones 30, Nikkei 225
Market-cap-weighted	Total market value	No change (price × shares = same)	S&P 500, FTSE 100

In price-weighted indices a company’s influence is determined by its share price. This means that if a stock splits, its proportional part of the index will diminish significantly. For example, Apple’s 2020 stock split changed it from being the top weighted stock within the DJ30 all the way down to number 16.

Market-cap-weighted indices like the S&P 500 Index or FTSE 100 Index calculate weightings based on total market value. Since this figure remains constant during a split, the company’s index weighting stays the same.

How Does a Stock Split Impact Share Price?

A stock split mechanically reduces a company’s share price by the split ratio. Taken at face value, the process can be considered to be an administrative process which shouldn’t materially impact the value of your investments. But the situation can be more nuanced than that.

Historical data suggests companies announcing splits often experience positive “real” price performance. This correlation doesn’t guarantee future results, but does reflect that stock splits are typically a sign that a company’s share price has already risen and might continue doing so.

According to data compiled by Bespoke Investment Group for the period between 2015–2020:

• The average price changes for stocks of companies that announced splits has been an additional 2.3% from the time the split was announced until the time it took place. 
• Nearly 70% of these stocks outperformed the S&P 500 index during that time. 
• The average stock price fell 0.3% immediately after the split.
• Over the following year, these companies gained an average of 9.8%.

Past performance is not an indication of future results.

Each stock split needs to be considered on a stand-alone basis but there are potential reasons why a stock split is followed by a share price rise which might not be completely coincidental. The possible factors in play include:

• Stock splits are seen as an indication of previous strong performance.
• Announcements of a split occurring can increase the profile of a company and draw in new investors. 

What Is a Reverse Stock Split?

A reverse stock split consolidates existing shares into fewer shares, increasing the price per share while reducing the total share count. It is the opposite of a regular stock split but with the same neutral effect on market capitalisation.

In a reverse split, if a company announces a four-for-one reverse split, and each share is currently worth $50, the new share price would be $200 and a shareholder that has eight shares would now have two.

The mechanics of a reverse stock split are laid out in the table below.

Reverse Ratio	Shares Before	Shares After	Illustrative Price Before	Illustrative Price After	Fractional Outcome Possible?
1-for-4	100	25	$10	$40	No
1-for-5	100	20	$5	$25	No
1-for-4	15	3.75	$10	$40	Yes
1-for-10	7	0.7	$2	$20	Yes

Companies may execute reverse splits for a variety of reasons:

• To meet exchange listing requirements, for example if an exchange requires a minimum share price.
• To appeal to institutional investors who may have restrictions on purchasing low-priced shares
• To reduce long-term administrative costs associated with a large shareholder base.

How does a reverse stock split affect traders and investors?

Unlike a normal stock split, in which the number of shares is simply multiplied by the split ratio, a reverse split could leave a shareholder with fractional shares. If this happens companies typically offer cash-in-lieu payments or rounding policies to handle these fractions.

For example, if a certain shareholder has five shares, and the reverse stock split is four-for-one, they will end up with 1.25 shares. In this case, most companies would simply liquidate the fractional share and give the shareholders the difference in cash.

Different brokers and companies handle fractional outcomes differently. Some round up to the nearest whole share, others round down, and many provide cash compensation for the fractional portion. 

How Do Stock Splits Work on eToro?

eToro automatically processes stock splits by adjusting your position’s unit count and average price according to the split ratio, usually without requiring any user action. All other things being equal, the total value of each position will not change.

The mechanical sequence follows this pattern: 

1. The split ratio is applied to your holdings 
2. Your unit count updates to reflect new share quantity 
3. Your average purchase price adjusts proportionally 
4. Your position that was previously composed entirely of whole shares could potentially now have fractional shares
5. You will not be forced into liquidating part of a stock position for cash
6. Your position value remains unchanged

On eToro it is highly unlikely that any action would be needed from the account holder, but the broker may communicate with its users ahead of time, letting them know of an impending split. The platform’s infrastructure is designed to process these corporate actions automatically, allowing you to focus on your investment strategy rather than administrative tasks.

Final thoughts

Taken at face value, a stock split can be considered to be an administrative process which shouldn’t materially impact the value of your investments. But the situation can be more nuanced than that, as stock splits are typically a sign that a company’s share price has risen. 

Stock splits are seen as an indication of previous success and stories of a split occurring are shared by financial news sites which can increase the profile of a company and draw in new investors.

Learn more about managing your investment portfolio by joining the eToro Academy.

FAQs

How can I buy an “expensive” stock?

The availability of fractional shares on platforms like eToro can reduce the necessity for splits, as investors can already access high-priced shares with smaller amounts.

Are taxes due after stock splits?

Stock splits are not a taxable event for investors. You are not buying or selling shares, and the transaction does not change your ownership interest. Income must be reported after the sale of shares, and that doesn’t happen with a stock split.

What is the adjustment to the futures and options contract due to a stock split?

If a stock split changes the price of a stock, the futures and options contracts relating to that stock are modified to ensure that their value is not affected by price changes resulting from the split.

For example, if a company’s shares are split 2-for-1, the number of shares underlying a futures or options contract doubles. The contract price is also adjusted, so the price per share is halved in the case of a 2-for-1 split.

Are stock splits good or bad?

Even if a stock split doesn’t affect the value of your investment, it’s usually a positive development for investors. It shows that the company is confident and intends to raise additional funds.

Do the costs of stock splits eat into company profits?

There are administrative costs associated with stock splits and some stock exchanges charge higher fees for a larger share count. These exchange fees are often capped at a few hundred thousand dollars per year. In general, the cost of a split is largely considered non-material, especially when carried out by companies which have revenues of billions of dollars.