Updated: Sep 2, 2021
By Michael Mooney, CFP
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In the news, you may have heard different companies announcing Stock Splits. Separately, you may have also heard about Dividends or Stock Buybacks. What are these terms and how do they affect your investments?
A stock split is voted on by a company’s Board of Directors to change the number of shares of a stock that are outstanding. There are two types of splits – a traditional stock split, where the number of shares goes up and the per share price goes down, and a reverse stock split, where the number of shares goes down and the per share price goes up.
How do stock splits work?
Let’s say you and your three friends are sharing a pizza with eight total slices. Each of you will get two large slices of pizza. If you cut each of the slices in half, the pizza will still be the same total size and each of you will have the same amount of pizza, but you will now have four smaller slices instead of two large slices.
If you own ten shares in a company with a share price of $1,000 per share, and they announce a 5:1 split, the per share price will decrease to $200 per share, but you will now have fifty shares instead of ten.
Does a stock split affect the value of my investment?
The short answer is no. However, some analysts believe that investors (especially smaller or “retail” investors) are more likely to purchase a stock with a share price of $20 than $200. As a result, it is possible that a 10:1 split from $200 could cause increased buying demand. However, as some investment companies are now allowing for the purchase of fractional shares, this is less applicable today. Many retail investors can now purchase half a share if they cannot afford a full share.
What is the point of a reverse stock split?
Reverse stock splits are less prevalent, but are still a key tool that is used by smaller or struggling companies. Stock exchanges, such as the New York Stock Exchange (NYSE), have minimum share price standards for companies. In the case of the NYSE, if the price of one share drops below $1, the company could be delisted from the exchange. Rather than getting delisted, companies that are in this danger will conduct a reverse split. If there are 10,000,000 shares outstanding of a company that is trading at $0.75/share, a 1:5 reverse split would decrease the shares to 2,000,000 and increase the share price to $3.75/share, which would help keep the stock from getting delisted.
A buyback is exactly as it sounds – it is when a company purchases back its own shares from the market. Similarly to dividends, buybacks are funded by extra cash on hand from company earnings. It reduces the total number of shares outstanding, which will increase the ownership percentage of each investor. They most often occur when companies believe that their share price is too cheap on the open market.
How do buybacks work?
If an investor has 100 shares of a company with 10,000 total shares outstanding, they will own 1% of the company. If that company buys back 1,000 shares with extra cash on hand, suddenly there will only be 9,000 shares outstanding. However, the investor will still own 100 shares in the company, meaning that their stake has increased to 1.11% (100 out of 9,000).
Similarly to a stock split, dividends are voted on by the company’s Board of Directors. A dividend is a distribution of earnings made by public-listed companies to their share holder. It is most often in the form of cash, but can also be made in additional shares of stock.
Do all stocks issue dividends?
No – Dividends are mostly issued by established companies, with a long track record of success and profitability. Companies that are growing are more likely to invest their extra cash back into the company for further development rather than issuing that cash to shareholders.
What does Yield mean for a stock?
A stock’s yield is the percentage of dividend as a portion of the total price of the stock. If a stock trading at $100 per share issues a $1 dividend quarterly, then it will have a 4% yield.
Where do my dividends go after I receive them?
Dividends are most often paid to cash in your account or reinvested directly into the stock or fund.
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.