What is a Stock Split?

Understanding Stock Splits:

When diving into the world of stock trading, you'll often come across terms that may seem complex at first but are essential to grasp. One such concept is the "stock split." Whether you're a seasoned investor or trader, or you are just starting to explore the stock market, understanding what a stock split is and how it impacts your investments can significantly enhance your trading and/or investment strategy.

What is a Stock Split?

A stock split is a common corporate action where a company divides its existing shares into multiple shares. While this increases the total number of shares available, it doesn't change the overall value of your investment or the company’s market capitalization. The main goal of a stock split is to make shares more affordable for investors, thus increasing liquidity in the stock market.

For instance, imagine a company’s stock is trading at $100 per share. If the company decides to execute a 2-for-1 stock split, every existing share is split into two, reducing the price per share to $50. Although the price per share decreases, the total value of your investment remains the same because you now own twice as many shares.

Forward Stock Split vs. Reverse Stock Split

It's important to distinguish between a forward stock split and a reverse stock split, as both have different implications for stock trading.

Forward Stock Split: This occurs when a company increases the number of its outstanding shares by issuing more shares to existing shareholders. This process decreases the price per share without changing the overall market capitalization of the company. For example, in a 2-for-1 forward stock split, every shareholder receives one additional share for each share they own, doubling the number of shares they hold. If a stock was trading at $100 before the split, it would trade at $50 after the split, with shareholders now owning twice as many shares. Forward stock splits are often executed to make the stock more affordable and attractive to a broader range of investors, particularly retail investors.

Reverse Stock Split: In contrast, a reverse stock split reduces the number of a company’s outstanding shares by consolidating them into fewer shares. This increases the price per share while maintaining the company’s overall market capitalization. For instance, in a 1-for-2 reverse stock split, every two shares owned by a shareholder are consolidated into one share. If a stock was trading at $10 before the reverse split, it would trade at $20 after the split, with shareholders now holding half as many shares. Reverse stock splits are often used by companies to increase the stock price, especially if the share price has fallen too low. A higher share price can help a company meet the minimum price requirements of stock exchanges, avoid delisting, and improve the stock's perception among investors.

Understanding the difference between these two types of stock splits is crucial for making informed decisions in stock trading and/or investing.

A Relevant Example | NVIDIA's 2024 Stock Split:

A prime example of a stock split in action is NVIDIA’s recent ten-for-one forward stock split, effective June 7, 2024. This decision was made to make stock ownership more accessible to a wider range of employees and investors. NVIDIA's split increased the number of shares tenfold while reducing the price per share proportionally. For each share held, shareholders received nine additional shares, significantly lowering the price per share and making it easier for more investors to participate in the stock market.

This stock split came on the heels of record-breaking financial results for the company. In the first quarter of fiscal 2025, NVIDIA reported an unprecedented quarterly revenue of $26.0 billion, marking a 262% increase year-over-year. The split was announced as part of NVIDIA's broader strategy to capitalize on their growth in the data center market, particularly driven by the rising demand for generative AI and AI infrastructure.

For investors engaged in stock trading, NVIDIA's stock split presents a compelling case of how such corporate actions can make high-performing stocks more accessible and potentially attract a larger pool of investors. By understanding this real-world example, you can see how stock splits might impact the stock market and influence your trading strategy.

The Impact of Stock Splits on Your Stock Trading Strategy:

For stock traders and investors, stock splits can present unique opportunities within the stock market. After a stock split, the reduced price per share can lead to increased interest from retail investors, potentially driving up demand and price over time. However, it’s important to note that a stock split doesn’t inherently change the value of the company; it simply changes the share price and the number of shares in circulation.

When trading stocks, it’s essential to consider the psychological impact a stock split might have on the market. While the fundamental value of your investment remains the same immediately after the split, the perception of a more affordable stock can attract new investors, potentially influencing future price movements.

Final Thoughts:

Stock splits are a valuable tool for companies and an important concept for anyone involved in stock trading and/or investing. By understanding how stock splits work and their effects on the stock market, you can better navigate your trading or investment strategy and make more informed decisions.

As you continue to explore the stock market, keeping an eye on corporate actions like stock splits can help you stay ahead in the ever-evolving world of stock trading. Whether you're aiming to diversify your portfolio or capitalize on new opportunities, being knowledgeable about stock splits, as illustrated by NVIDIA's recent example, is a crucial part of your stock trading journey.

If you’re looking to deepen your understanding of the stock market or refine your trading strategy, staying informed about concepts like stock splits can give you a significant edge in your trading and/or investment endeavors. Choosing a broker that has technology to help you capitalize on market opportunities is also crucial. We encourage you to try a free demo of our hallmark trading platform, Lightspeed Trader.