While a stock's value is not found in its price, companies know that the price is a major psychological indicator of value. A stock split is designed to give the impression that a stock is more affordable by allowing investors to buy more shares for less money.
A stock split is simply one share of stock being split into more shares. The size of the split is set by the company and represented with a ratio. A 1:2 stock split means that 1 share is split in to two shares. A 1:10 split means that 1 share is split in to 10.
No Change in Value
If a stock split takes place, the investor who held shares prior to the split does not lose or gain money. Just as a $10 bill can be split in to two $5 bills without any gain or loss in value, a stock can do the same.
Companies know that smaller investors want to pay less to get more shares, so by pricing their stock at an affordable level, it allows the individual investor to buy more shares without actually getting more.
When a stock split takes place, the amount of shares that are for sale to the public increases. When a 1:2 stock split takes place, the amount of shares being offered to the public doubles.
A stock that is only a few dollars per share risks being seen as a penny stock (speculative securities of very small companies priced below $5), by the public. To combat that, a reverse stock split may take place where a company will make multiple shares in to one share. For example, a 2:1 reverse split is when 2 shares are made in to one. The price of the share doubles and the amount of shares available to the public is reduced by 50%.
- Comstock/Comstock/Getty Images