Stock splits & dividends

If a company feels its stock price is too expensive or too cheap, it can consider performing a stock split.
There are two types of stock splits - forward and reverse. Forward stock splits increase the number of
outstanding shares, while reverse stock splits decrease the number of outstanding shares.

Forward stock splits

Forward stock splits are pursued when a company feels its stock price is too expensive for the average
investor. Let’s assume ABC company’s stock price has risen to $500 per share, which is relatively
expensive (most stocks trade between $30 - $150). ABC company could consider decreasing its stock
price through a forward stock split. This would increase the number of shares a stockholder owns, but the
stock price decreases proportionately. Let’s work through a few examples.

As you can see in these examples, the stockholder always ends up with the same overall value ($27,000 in
the last example). It’s the number of shares owned and the market price that changes. As an analogy,
imagine you have an apple pie, which we’ll consider as one unit of pie. If you were to cut that apple pie in
half, you technically have two units of pie. While you have more pie units, you don’t end up with more
overall pie.

Sidenote
Even vs. uneven stock splits
Stock splits can be considered even or uneven depending on the setup. An even stock split is any stock
split that ends in the number’ 1.’ Here are some examples of even stock splits:

• 2:1 stock split - 4:1 stock split - 7:1 stock split

If a stock split ends in any number other than 1, it’s considered uneven. Here are some examples of
uneven stock splits:

• 3:2 stock split - 5:4 stock split - 7:2 stock split

Reverse stock splits

Reverse stock splits are pursued when a company feels its stock price is too low (the opposite of forward
splits). Instead of waiting for market demand to increase its stock price, a company could do a reverse
stock split and achieve an immediate stock price increase.

Stock splits (forward and reverse) affect all stockholders, so there is never a change in proportionate
ownership. If an investor owns 25% of the outstanding shares in a company before a stock split, they’ll
still own 25% of the shares after the stock split. Back to our pie analogy - imagine you and three of your
friends slice a pie into fourths, giving each person a 25% pie stake. Cutting your slice in half would
resemble a 2:1 forward stock split. Do you have more pie slices? Yes. Is there less pie per slice? Yes.
Regardless, you still own 25% of the overall pie!

To summarize, stock splits do not affect overall investment value. However, the price per share and the
number of shares will change. Although stock splits are relatively insignificant in the long run, they
require approval* from stockholders.
*Stock splits (forward and reverse) affect a common stock’s par value. While par value on common stock
is a relatively unimportant accounting measure, actions impacting par value generally require shareholder
approval.

Stock dividends

Stock dividends also offer an opportunity to obtain extra shares. Like stock splits, stock dividends are
simply a “reshuffling” of numbers for the company to manipulate its stock price. If a company pays a
stock dividend of 25%, each investor will end up with 25% more shares. However, each share will fall
proportionally in price. Ultimately, a stock dividend does not increase the overall value of a stock
position. Good news - if you understand the math behind stock split calculations, you will likely
understand stock dividend math. Here’s an example of a stock dividend question:

In conclusion, stock splits and dividends change the number of outstanding shares but don’t result in
shareholders gaining or losing overall value. Both accomplish the same thing (manipulating the price
upward or downward), but some differences exist.

The most significant difference to be aware of relates to voting. Stock splits require shareholder approval,
while stock dividends do not (similar to cash dividends). With the consent of the Board of Directors, a
stock dividend can occur whether the stockholders want it or not.

Key points
Forward stock splits result in:- More shares outstanding - Lower price per share - Same overall value

Reverse stock splits result in:- Fewer shares outstanding - Higher price per share - Same overall value

Stock dividend consequences - More shares outstanding - Lower price per share - Same overall value

Stockholder approval (voting) - Stock splits require approval - Stock dividends do not require approval