Hey everyone. This is Kirk here again from Option Alpha and in this video, we are going
to walk through stock splits. They’re a little bit confusing at some points, but we’re
going to try to break it down for you guys, so you understand exactly what they are and
how they have an impact on the shares outstanding and the share price and the company valuation.
Board of Directors can choose to do a lot of different things with their stock. One
of the things that they can choose to do is go through splits and even reverse splits
which we’ll cover in another video. In this one, we’re going to go through two examples
where we go through a 2:1 split and a 6:1 stock split. And essentially, what they’re
doing is just changing the number of shares outstanding and the value of the individual
shares that are out there.
One thing you have to understand about stock splits, however, is that the stock split itself
has literally no impact on the valuation of the company at the time. In fact, it has no
impact whatsoever unless the impact is realized after the split occurs which we’ll talk
about here in a little bit. But let’s say for example that we have a stock that’s
trading at $54 pre-split. This stock is $54 per share, so if you want to go out into the
open market and buy shares in some company, right now, you’d have to pay $54 per share
and let’s assume though that the company is now worth somewhere around $5,400. This
is a major market cap, but I’m just keeping the math very simple. There’s really only
100 shares outstanding and so, pre-split, you have 100 shares that are each worth $54
a share which gives you a total value of the enterprise of $5,400. Again, very simple math
here, so you understand the concept. If the company was to go through a 2:1 split, essentially,
what that means is that every one share that is outstanding now gets split into two shares.
This one share right here that is worth $54 (and there’s 100 of them) now get split
and now, we have twice as many shares that are out there.
And so, you would look at it like this as this company now has 200 shares that are outstanding
and each of those shares are now worth $27 per share. And so, that’s how a 2:1 split
works. Each of the existing shareholders if you’re holding one share of stock in this
company for $54, well, now you have twice as many shares for $27. Now, you see that
the math actually works out exactly the same. That 200 shares at $27 is exactly what the
company is worth now. Same thing that it was worth before of $5,400. This actually does
not change at all and that’s the really important point. A lot of people perceive
a stock split as the company being cheaper and that’s how maybe they want investors
to look at the company. Maybe the company is getting too big that it doesn’t allow
the average person or a typical investor to buy shares in the company. You look at a company
like Berkshire Hathaway which has really never split in its entire history, so it’s multiple
thousands of dollars or hundreds of thousands of dollars for the shares, but it’s still
the same company and it’s still valued the same even if it went through a split.
Let’s go through another example here where we look at the same 100 shares of stock that
are out there and the $54 per share that we have for those stocks and let’s assume now
that the company goes through a 6:1 stock split. And so, in this case, every share is
now going to be equivalent to about 6 years after we increase the number of shares outstanding
by a factor of 6. Now, we have this company which has not 100 shares outstanding after
the split or post split, but 600 shares outstanding and each of those shares is now worth $9 per
share. Now, again, when you look at the math behind this, the company really did not change
at all in value. It’s just the distribution of how we calculate this. It’s now not 100
times $54 per share to get the market capitalization of the company. Now, it’s 600 shares times
$9 per share and now, we have the same company, the same value still at the end of the day.
This is essentially what stock splits are. They’re just literally a redistribution
of the number of shares that are outstanding. Maybe they want to increase the number of
shares that are outstanding. Maybe in a reverse split, they want to decrease the number of
shares outstanding and it changes the per share price. But what is important here is
that the actual value of the company for the actual split itself does not change. Clearly,
the company can change in value after that when the stock shares start trading and maybe
these lower prices are more attractive to investors and maybe for a time and maybe gives
the company a little bit of a boost and more people can see it and it’s now in their
wheelhouse and they can actually trade it. But the end result is that the company doesn’t
change from a stock split itself. Hopefully this helps out. As always, if you guys have
any questions, let us know and until next time, happy trading.