1. Money

What Is a Stock Split?

By

What is a Stock Split?

If you've ever asked, "What is a stock split?" then we have the answer for you! A stock split is a way a company can lower its stock price to make shares more affordable. It involves issuing shares on a pro-rata basis to existing stockholders.

Question: What Is a Stock Split?
Answer: A stock split is essentially when a company increases the number of shares. For example, if you owned 25 shares of XYZ at $15 per share, and there was a 2-1 stock split, you would then own 50 shares worth $7.50 each. Why do companies issue splits if you still have the same amount of money?

Liquidity. Some companies believe that their stock should be inexpensive so more people can buy it. This creates a condition where more of the company's stock is bought and sold (this is called "increased liquidity"). The problem, in theory, is that the increased activity will also leads to bigger gains and drops in the stock, making it more volatile.

Many investors believe splits are a good thing. (Their thinking goes "Well, if the stock was at $15, and now it's at $7.50, it has to go back up to where it was!) This is wrong. The stock is where it was... remember that each share now represents half of the equity in the company that it did before the split. That means that each share is entitled to half the dividend, half the earnings, and half of the assets that it once was.

A few corporations have been famous for their no-split policies. The Washington Post has traded well into the $600 per share range, and Berkshire Hathaway, which was at $8 a share in the 1960's, has traded as high as $150,000. This has created the welcome condition of a stable shareholder base.

More Information About Investing in Stock

For more information, read our Guide to Investing in Stocks and What Is a Stock Split?, which is part of our 101 Things Every Investor Should Know About Stocks special.

©2014 About.com. All rights reserved.