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Trader Toolkit: Stock Splits Explained

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Ever notice a stock jump up to 200 percent or get cut in half without news? Well, that stock might have just gone through a stock split. Splits are corporate actions that manage the share price to better market the stock to traders and investors. Splits can move in either direction — you can get more shares for what you hold or can get less — and each type of move signals something different.

Forward Stock Split
A forward stock split is a corporate action in which the company increases the amount of shares outstanding by a certain multiple, and then decreases the stock price by the same factor. This usually occurs when a stock’s price is too high, and a lower price would appeal to more investors, which could, in turn, improve liquidity. Consequently, the bid-ask spread on the stock could be tighter.

For example, Copart Inc (CPRT) issued a two-for-one stock split on April 11. Therefore, the stock’s price would be cut in half, while the shares outstanding would increase by a factor of two. However, the market cap effectively remained the same. Here’s a look at the historical prices around the stock split:

Source: Yahoo Finance

Reverse Stock Split
A reverse stock split, by comparison, is typically used by companies with a cheaper stock price that want to raise that price, also to become more appealing to investors and traders. With a reverse stock split, the price would be multiplied by the factor, while the outstanding shares are divided by that factor. Again, the market cap remains the same.

On May 11, for example, DryShips (DRYS) issued a one-for-seven stock split. In other words, its closing share price the previous day would be multiplied by seven, and its outstanding shares, at the time, would be divided by seven. Thus, if you owned 700 shares at 96 cents per share before the split, you owned 100 shares at roughly $6.72 each when the deal was done.

Source: Yahoo Finance

Stock or scrip dividends
In a move that often feels like a small stock split, some companies use stock to pay dividends; in these so-called “scrip dividends,” the company issues additional shares in place of cash, conserving their cash resources. Like an ordinary forward split, the price of the stock is adjusted — in this case by the amount distributed per share — and the number of shares an investor holds increases.Any fractional amounts left over after new shares are purchased are typically paid to shareholders in cash.

Final Thoughts
If you have a position in a stock, you should be aware of corporate actions, such as stock splits. If you don’t check a stock’s price regularly and are shocked by how it has moved when there was no news that you’re aware of, take a deep breath and look first to see if the price changed due to a split. Then learn more about how the split worked, how your position has changed and whether analysts believe the move will have any long-lasting effects on the value of the company.

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