A stock split is a corporate action where a company increases the number of its outstanding shares while proportionally reducing the price per share. This move does not change the overall market capitalization of the company, but it adjusts the stock’s price and share structure to make it more accessible or attractive to investors.

When a stock split occurs, the company issues additional shares to existing shareholders based on a predetermined ratio. For example, in a 2-for-1 stock split, shareholders receive two shares for every one share they currently hold. Consequently, the share price is roughly halved to maintain the same total value of holdings. The formula to understand this adjustment is:

New Share Price = Old Share Price / Split Ratio
New Number of Shares = Old Number of Shares × Split Ratio

For instance, if a stock trading at $100 undergoes a 2-for-1 split, the new price will be $50 per share, and the number of shares outstanding will double.

One of the most famous examples is Apple Inc.’s 2020 stock split. Before the split, Apple’s shares traded around $400. After announcing a 4-for-1 split, shareholders received four shares for every one they owned, and the price adjusted to approximately $100. This made the shares more affordable for a broader range of investors and increased liquidity in the market. Importantly, this split didn’t affect Apple’s market capitalization or the value of investors’ holdings.

Stock splits are often used by companies whose share prices have risen significantly, making their stock appear expensive and potentially limiting smaller investors from buying in. By reducing the price per share, companies can make their stock seem more accessible without changing the company’s actual value.

A common misconception is that stock splits increase the value of an investor’s holdings or signal a company’s improved financial health. In reality, the total value remains unchanged immediately after the split. Stock splits are largely cosmetic and do not affect the underlying fundamentals. However, a split can be perceived positively by the market, sometimes leading to increased demand and a subsequent price rise, but this is due to market psychology rather than the split itself.

Another point to note is the difference between a stock split and a reverse stock split. While a stock split increases the number of shares and lowers the price, a reverse split reduces the number of shares and increases the price per share. Reverse splits are often used by companies trying to avoid delisting from stock exchanges or to make their shares appear more valuable.

Investors and traders sometimes wonder how stock splits affect dividends and earnings per share (EPS). Dividends are typically adjusted proportionally so that the total dividend payout remains the same, but the dividend per share decreases in line with the split ratio. Similarly, EPS is recalculated to reflect the increased number of shares outstanding, ensuring that fundamental metrics are consistent post-split.

In summary, a stock split is a strategic move by companies to adjust their stock price and share count without altering the company’s overall value. While it can improve liquidity and make shares more affordable, it does not inherently increase shareholder wealth. Investors should be cautious not to assume a stock split is a guaranteed indicator of future price gains.