A stock split is the process of decreasing the price of stock and increasing the number of shares proportionally. Stock splits are really rather easy to understand. A typical example is a 2-for-1 stock split. If you own 100 shares of a company that trades at $100 a share and it declares a 2-for-1 stock split, you will own a total of 200 shares at $50 a share after the split. This is no way affects the value of what the shareholders own, if you happen to own shares that are splitting.
Often times when you see stocks that are rising over the years, investors tend to think that the stock costs too much or has already reached its peak and is going to go back down. Here is where the stock split comes in. When a company’s stock price starts getting rather high, companies often split their stock when they believe the price of their stock exceeds the amount smaller individual investors would be willing to pay for the stock. What this does is that by reducing the price of the stock, companies try to make their stock more affordable to investors.
The most common splits are 2-for-1, 3-for-2, 5-for-4, and 3-for-1. But companies can split their stock in any number of ways, 5-for-1, 10-for-9, etc. An easy way to determine the new stock price is to divide the previous stock price by the split ratio. In the case of our example, divide $100 by 2 and we get the new trading price of $50. If a stock were to split 5-for-4, we’d do the same thing: $100/(5/4) = 100/1.25 = $80.
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