Stock splits

In short

A friend of mine once bragged that his stock "doubled" overnight, and he was a little let down when I asked him to check his account balance. If you own shares of a company that announces a split, nothing about your wealth changes that day. You get more shares, and each one is worth proportionally less. Look at your statement before and after, and you will see the total stays put. Check whether your broker holds fractional shares if you ever have a leftover piece. Read the company's own announcement to learn the date and the ratio. Keep any buy or sell decision separate from the split itself, because the split gives you no reason either way.

The whole of it

What it is

You have probably cut a pizza into eight slices when the table wanted twelve. The pizza did not grow. You just made smaller pieces. A stock split works the same way. A company divides each existing share into several new ones, so the share count goes up and the price per share goes down.

The most common kind is a forward split, such as two for one or ten for one. In a two for one split, one share becomes two. A reverse split goes the other way. A company folds several shares into one, so a one for ten reverse split turns ten shares into a single share at a higher price.

A story helps here. A neighbor of mine owned a handful of shares in a grocery chain. When it split three for one, she called me worried that she had lost two thirds of her money, because the price on her screen had dropped by that much. She had not. She had three times the shares at one third the price. The total was the same.

Companies do this for plain reasons. A lower price can make shares feel easier to buy in round lots, and it can make employee stock plans simpler. A reverse split often happens when a price has sunk so low that an exchange may threaten to remove the stock from its list. The company explains its own reasons in its filings.

How it works

If you are holding shares when a split takes effect, your broker handles the whole thing. You do not fill out a form or pay a fee for the split itself. Three dates matter, and the company announces them. The record date decides who is owed the new shares. The payable date is when the new shares are issued. The ex date is the first day the stock trades at its adjusted price.

Here is the math in a form you can check. Take the number of shares you own and multiply by the split ratio to get your new share count. Then divide the old price by the ratio to get the new price. Multiply the new count by the new price, and you land back where you started, apart from normal market movement during the day.

Your cost basis changes too. Cost basis is what you paid for your shares, and it is what you use to figure a gain or loss when you sell. After a forward split, your total cost stays the same, but it is now spread over more shares, so the cost per share drops. Your broker usually updates this on your behalf. Check that it did.

What about the leftover piece? Say you own seven shares and the split is three for two. Seven times three, divided by two, gives ten and a half. Some brokers hold the half share for you. Others pay out cash for the fraction. Your broker's rules will say which.

The numbers, and where to find yours

Splits do not come with a yearly dollar limit, so there is no government figure to plug in. What you want are the facts about your own holding. Look for your share count, your price per share, and your cost basis on your brokerage statement. The company posts its split terms in a press release and in a filing with the Securities and Exchange Commission. You can search those filings for free on the SEC's EDGAR database, and the company's investor relations page usually repeats the news.

One tax point is worth knowing. The Internal Revenue Service says that a plain stock split is generally not taxable when it happens, because you have not sold anything. Its Publication 550, called Investment Income and Expenses, covers how basis is adjusted after a split. Read that publication, or ask a tax professional, before you rely on a detail for your own return.

A worked example

Let me tell you about a woman named Dana. Dana owns 40 shares of a company, and the stock trades at 300 dollars a share. Her holding is worth 40 times 300, which is 12,000 dollars. She paid 200 dollars a share, so her cost basis is 40 times 200, or 8,000 dollars.

The company announces a four for one split. Dana's new share count is 40 times 4, which is 160 shares. The new price is 300 divided by 4, which is 75 dollars. Her holding is now 160 times 75, and that is 12,000 dollars. Same wealth. More slices.

Her cost basis stays at 8,000 dollars in total. Per share, it is now 8,000 divided by 160, which is 50 dollars. Before the split it was 200 dollars. Both numbers describe the same 8,000 dollars.

Now try a reverse split. Dana owns a second stock, 500 shares at 2 dollars each, worth 1,000 dollars. The company does a one for ten reverse split. Her new share count is 500 divided by 10, which is 50 shares. The new price is 2 times 10, which is 20 dollars. Her holding is 50 times 20, and that is still 1,000 dollars. Fewer slices, bigger ones. No new wealth either way.

Where it goes wrong

I have watched good people trip over this, and it is never because they were careless. The split feels like news, and news feels like a signal. So the first mistake is thinking a split makes a stock a bargain. A lower price per share is not a lower price for the company. The business is worth what it was worth a minute before.

The second mistake is chasing the headline. Stories about a stock "soaring after a split" are easy to find. But a split does not cause a company to earn more. If a price moves, other news probably moved it. I cannot tell you what any stock will do, and neither can the press release.

A third trap sits in the reverse split. A company that folds its shares to lift a sinking price has changed the number on the screen, not the trouble underneath. Read why it did so in its own filing.

Last, mind your records. Brokers sometimes adjust cost basis late or wrongly, especially for shares you moved from another firm. Compare your statement to your own notes. A wrong basis can lead to a wrong tax bill later.

Questions to answer before you leave this page

Do you know how many shares you own right now, and what your total is worth, so you can check that a split changed neither? Have you found the record date, payable date, and ex date in the company's own announcement? Does your broker pay cash for a leftover fraction or hold it as a piece of a share? Did your cost basis per share adjust after the split, and does the total still match what you originally paid? Are you tempted to act because of the split itself, and if so, what other reason do you have? Who will you ask, whether your broker or a tax professional, if the paperwork looks wrong?