When investing in the stock market, it is important to understand how your ownership interacts with the board of directors. In return for your investment, you have certain voting rights to help shape the direction of the company. However certain procedures, such as stock splits, are reserved for the board of directors. A forward stock split is a maneuver where you will suddenly find more shares of company stock in your portfolio.
The principles of a stock split are fairly straight forward. If a company decides to split a stock, then each investor will now have more stock than they had previously. Stock splits occur in ratios. For instance, a two to one stock split means that you would have double the amount of shares you previously had. A three to one means that you would have triple the shares. If a company wants to lower the amount of shares available in the marketplace, it can enact something called a reverse stock split which works in just the opposite manner. If two to one reverse split was carried out, an investor would have half the shares he previously had.
Companies enact stock splits for a couple of different reasons. If a share price has risen to high levels above their competitors, companies may split the stock to bring that price more in line with peers. Also, if stock prices are high, that can squeeze out smaller investors who can only afford a few shares. Finally, companies enact a stock split so that there is more liquidity of their shares in the marketplace. This makes physically trading the stock easier as their are more shares to go around. Conversely, companies enact reverse stock splits for opposite reasons. They want to raise the price of their shares, lower the number of stocks available, and bring the price of their stock more in line with their peers.
It is important to note that when a stock split occurs, financial numbers, such as the market capitalization of a company remains exactly the same. For instance if a company had 1 million shares one the market prices at $10 per share, their market cap would be $10 million. If it performed a forward stock split of 2 for 1, then it would have 2 million shares on the market worth $5 per share. This would still equal a market cap of $10 million.
Reverse Forward Split
Many people refer to a forward stock split as simply a stock split. When they use the term "forward" it is usually due to the fact that it is following a reverse split. This maneuver is called a Reverse / Forward Split. This can seem confusing, but the board of directors may feel they have a good reason for this type of split. In a Reverse / Forward Split, a company may reverse the shares by a large factor, say 100 to one. This means that if an investor has less than 100 shares he would automatically be cashed out. The company would pay him cash for his shares. The company would then perform a forward split immediately thereafter. The ratio may be the same 100 to one or it might be less, it is up to the board of directors. The purpose of the Reverse / Forward Split is to shake out small investors. Every investor must be provided with voting materials and other correspondence which costs money. This allows the company to lessen their costs in that area. This can obviously prove frustrating to smaller investors, though if they would like, they may buy the stock back after the maneuver is finished using the money the company paid them to cash out.
Portfolio and Volatility
When a forward split occurs, your portfolio will look slightly differently than the day before the split occurred. First, you will have a multiple of two, three, four or more times the shares you previously had. Also, the stock price will be reduced by that same factor. As an investor, you should be aware that more shares on the market can cause higher volatility as more buyers and sellers can now trade at a faster pace.
Scott Damon is a Web content specialist who has written for a multitude of websites dating back to 2007. Damon covers a variety of topics including personal finance, small business, sports, food and travel, among many others.