What’s all the hype about forward stock splits?
When a growing company announces an upcoming stock split, there can be a lot of confusion about what it means.
Some traders rush to buy, thinking they’re getting something for nothing…
Not so fast.
You may get more shares, but do you really get more value?
Before you jump into the next stock that announces a split, read on…
I’ll tell you what a forward stock split is, how it differs from a reverse stock split, and what it means for your account if you hold stock through a split.
You might just find that a stock split isn’t all it’s cracked up to be…
Let’s do this!
Table of Contents
- 1 What Is a Stock Split?
- 2 Understanding How a Stock Split Works
- 3 Why Would a Company Do a Forward Split?
- 4 What Are the Disadvantages of Forward Stock Splits?
- 5 Forward Stock Split Examples
- 6 How Can You Calculate Forward Stock Splits?
- 7 Upcoming Forward Stock Split Calendar 2021
- 8 Frequently Asked Questions About Forward Stock Splits
- 9 The Bottom Line
What Is a Stock Split?
A stock split occurs when a company splits its existing shares into more or fewer shares.
They’re announced as a ratio.
For example, you could see it announced as a two-for-one, 2-for-1, or as a ratio like 2:1. All of them mean the same thing. After the split, you’d have two shares for each one you owned before the split.
Companies can do any split ratio they want — 4:1, 7:1, or even 20:1.
The first number tells you how many shares you’ll get for every share of the second number.
Since a forward stock split gives shareholders more shares, you might wonder, “is a stock split good?”
More shares in your account means more value right? Not exactly.
Let’s dip deeper into what a stock split is and how it can affect your account, then you can decide for yourself…
Understanding How a Stock Split Works
Forward stock splits can be confusing. Especially if you see changes to your account that you don’t understand. So let me break it down…
Stock splits don’t change a company’s value. They just change how the company’s value is divided among shareholders.
A stock split creates more shares of the company, so each share becomes worth less. With a reverse stock split, shares consolidate into fewer shares so each one becomes worth more.
If you hold a position in a company through a split, the number of shares you own will change. So will the price per share. But the overall value of your position will stay the same.
I’ll share some real-life stock split examples later in this post. But first…
Forward Stock Split vs. Reverse Stock Split
A forward split divides the existing shares of a company into more shares.
It’s a way for companies to create more shares without diluting shareholder value.
A forward split is generally considered a good thing. Even though the company doesn’t make any money from the new shares. It can mean the stock is in high demand and the market can support more supply.
I see sketchy penny stock companies do it all the time…
It’s a way for them to increase the stock price without adding any value to the company. It’s usually done so the company can meet the listing requirements of major exchanges. The Nasdaq and NYSE require companies to maintain a list price of $1 or more or they risk being delisted.
Another reason a penny stock company might do a reverse split is to generate more interest and volume in the stock. Because a lot of traders and hedge funds won’t trade stocks under $1.
Do Stocks Usually Go Up After a Split?
Like I said earlier, a forward split brings the stock price down and a reverse stock split increases the share price.
But since the market interprets a forward stock split as good news, the anticipation of the split can create hype and cause a stock to go up. We saw it happen with the forward splits in Tesla and Apple in 2020 … More on those examples later.
When a company announces a split, it can be a sign to traders that it’s an uptrending stock and in high demand. That can generate more interest and demand and drive prices up even higher.
But once the stock split occurs, the price will be adjusted lower based on the size of the split.
Then it’s up to the market to decide if the stock price goes up or down. The price could go up since more traders and investors can afford the lower price. Or it could go lower as shareholders who rode the hype up sell the news.
Why Would a Company Do a Forward Split?
If a forward split brings a stock price down, why would a company do it? Here are a few reasons a stock split might make sense to a company…
To Lower the Stock Price
When successful companies experience huge growth, the stock price may become out of reach for smaller investors and retail traders. That means less liquidity in the stock and limited shareholders.
A lower stock price means it’s more affordable to more investors and traders. And that can mean more volume and liquidity.
To Increase Demand
A lower price can also increase demand for the stock. The more traders and investors who can afford it, the more that can freely trade it. That can keep the stock trading high volume and more traders and investors interested.
What Are the Disadvantages of Forward Stock Splits?
The biggest disadvantage is more shares. It means each share’s worth a smaller percentage of the company.
It also means the stock will need more demand to push the price higher. That’s why companies usually do splits when their stock is in high demand and uptrending. That way there’s enough demand to absorb the excess supply.
Another disadvantage of a stock split is that the company doesn’t generate any capital for expenses or expansion. It doesn’t add any value to the company.
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Forward Stock Split Examples
Here are some real-life examples…
Tesla, Inc. (NASDAQ: TSLA)
Tesla, Inc. (NASDAQ: TSLA) announced a five-for-one forward stock split on August 11, 2020. The split was effective on August 31, 2020. That gave traders and investors plenty of time to drive the price higher in anticipation of the split.
Electric vehicle stocks were a smokin’ hot sector for most of 2020, which also helped drive up the price. The stock was running before TSLA announced the split. And yep, even after CEO Elon Musk tweeted that the stock was overvalued…
You can see on the TSLA one-year chart, the stock was up over the month before the split. But after the split announcement, it went even higher. The upward arrow shows when the split was announced. The downward arrow shows when the split became effective.
Here’s what I thought about the insane Tesla run-up before it announced the stock split…
Apple Inc. (NASDAQ: AAPL)
You can see from the AAPL one-year chart that the stock gapped up following the news of the split and continued upward. But once the split went into effect (marked by the downward arrow) the stock retreated.
The Trade Desk, Inc. (NASDAQ: TTD)
On May 10, 2021, The Trade Desk, Inc. announced a huge 10-for-1 stock split effective June 17. In this case, the stock crashed after the news. The split was announced as part of the company’s earnings report, so that could have impacted the price action.
How Can You Calculate Forward Stock Splits?
Here’s how you can calculate what a stock price will be after a split. You’ll need to know the ratio of the split and do a simple calculation…
Divide the current stock price by the split ratio to determine the share price after the split.
Let’s say you own 1,000 shares of a company at $25 when a four-for-one stock split becomes effective. You can divide the share price of $25 by four to come up with the value of each share after the split. In this case, each share would be worth $6.25 after the split.
Upcoming Forward Stock Split Calendar 2021
Pay close attention to the split ratios to determine whether it’s a forward or reverse split.
A forward split is announced with a larger number first, like four-for-one or 4:1. A reverse stock split is announced with a smaller number first like one-for-five or 1:5.
Frequently Asked Questions About Forward Stock Splits
Why Do Some Companies Not Split Their Stock?
Some companies may think having a higher stock price makes it look more valuable. A company may not split its stock if it’s not worried about having limited shareholders or if there are no liquidity issues in how the stock trades.
What Does a 4-to-1 Stock Split Mean?
If a company announces a 4:1 split it means each share will be split into 4 shares. It can also be worded as a four-for-one stock split.
How Do You Calculate a 2-for-1 Stock Split?
A two-for-one split means shareholders will own two shares after the split for each one they owned prior to the split. Each share will be worth half as much, so the overall value of shareholders’ positions doesn’t change.
The Bottom Line
A stock split doesn’t give shareholders more value. And as I showed in my examples, not all stocks go up after announcing a forward split.
So is a split good? That depends.
You can’t impose your will on the market. It doesn’t care what you want. So don’t buy into a stock thinking all forward stock splits go up. Trading’s not that simple.
But you won’t see me trade news of forward or reverse stock splits. And I don’t trade stocks like Tesla or Apple…
I didn’t have a mentor to teach me what to do and what not to do. That’s why I became a teacher — to be the mentor to traders that I never had. And having a mentor can greatly increase your learning curve. My 10+ millionaire students prove that.*
What do you think? Is a stock split good or bad? Let me know in the comments … I love to hear from you!
*Please note that reported trading results are not typical. Most traders lose money. It takes years of dedication, hard work, and discipline to learn how to trade. Individual results will vary. Trading is inherently risky. Before making any trades, remember to do your due diligence and never risk more than you can afford to lose.
While Tim Sykes has enjoyed remarkable success trading stocks over the years, earning an aggregate sum of over $7 million in trading profits between 1999 and 2021, his primary income derives from the sale of financial education products and subscription services offered by various businesses and websites in which he has an ownership stake.
This level of successful trading is not typical and does not reflect the experience of the majority of individuals using the services and products offered on this website. From January 1, 2020, to December 31, 2020, typical users of the products and services offered by this website reported earning, on average, an estimated $49.91 in profit. This figure is taken from tracking user accounts on Profit.ly, a trading community platform. Timothy Sykes has a minority shareholder interest in the platform. The typical success rate of users was based on the following methodology:
- From January 1, 2020, to December 31, 2020, 849,078 trades were uploaded to Profit.ly. 633,891 trades were “verified” (corroborated with trade account data).
- Instructor trades are ignored.
- Average P&L / trades is obtained by calculating total P&L and dividing by the total number of trades
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