Stock splits occur when a company decides that their stock price has risen to a level where it is getting harder for investors to buy it in small quantities. Normally a company will replace 1 of its shares with 2 or more new ones (ie 2 for 1 split). For example if the stock price of ABC Incorporated is $300 and the company wants to do a 2 for 1 split then each current share will turn into 2 new shares worth half as much or $150.
The important thing to note is that while the number of shares you own goes up, the value of each share goes down so your total investment will remain the same. Jason Zweig who wrote “Your Money or Your Brain” said very aptly that a stock split is like trading in a dime for two nickels.
Berkshire Hathaway (stock symbol BRK-A) run by Warren Buffet, is a very famous example of a company that has never split its stock. It currently trades for about $95,000 which makes it next to impossible for most investors to buy even 1 share! Fortunately there is a cheaper version of Berkshire Hathaway (called the baby Berk) (stock symbol BRK-B) which trades for a mere $3200.
Reverse stock split
The opposite of a stock split is called a reverse stock split. This is when a company decreases the number of shares and increases the value of each share. This usually happens when a stock has gone down in price. If the shares of a company trades at $0.50 then they might do a 10 to 1 reverse split which means that 10 old shares become 1 new share worth $5.00.
Can mutual funds split too?
In theory, mutual funds can split their unit prices, however since investors can buy partial units of mutual funds, there isn’t really any point in doing so.