What is a stock split, anyway?

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Last week, Google’s parent company, Alphabet Inc., announced that it will run a 20-1 stock split in July — a decision that lower the company’s share pricebut not its overall value.

When a company splits its stock, it splits each stock into multiple stocks, increasing the quantity while lowering the price. Professor of Finance at Georgetown Jacques Angel likened the procedure to giving change: “Think of it as the equivalent of giving change for $20 and getting two $10s.”

In the case of Alphabet’s 20-1 split, the $20 note is exchanged for 20 singles. Like breaking $20, the stock split does not change the value of the business. He just breaks it into little pieces.

“It won’t make company operations more valuable, but it will make things more convenient for shareholders,” Angel said.

When the price of a stock is high, it can be difficult for small investors to buy and sell. Alphabet’s high stock price of around $2,770 at the close of trading on Thursday could be prohibitive for many investors. The lower price makes the stock more accessible and easier to trade.

A stock split can also be used to send a message, depending on Andre KarolyiProfessor of Management and Dean of SC Johnson College of Business at Cornell.

“Research has shown that stock splitting is an effective mechanism by which managers – who have better information than the market about the company’s future growth prospects – can credibly signal to the market that better economic opportunities looming on the horizon,” he explained.

Karolyi said stock splits are often correlated with positive performance. “For nearly 50 years, stock splits have been proven to be associated with positive stock price reactions.”

Alphabet stock price increased by 7.5% following the announcement of the split. However, the news was accompanied by a strong earnings report, making it difficult to attribute the gain solely to the split.

For Alphabet, a lower price could also get the company included in the Dow Jones Industrial Average, a basket of 30 blue-chip stocks that many investors use as a barometer of market conditions. Alphabet’s current price is well above the components of the Dow Jones, where the most expensive stock belongs to United Healthcare, currently at just under $500.

“If you want to be included in the Dow Jones Industrial Average index, you can’t have a price that is very different from everyone else’s price in the index,” said Evan Rawleyassociate professor of strategy at the University of Connecticut.

While stock splits were once commonplace, they have become rare in recent years. In the S&P 500, an index broader than the Dow Jones, only two companies – Tesla and Apple – have split their shares in recent years, compared to nearly 50 splits among S&P companies in 2006 and 2007.

One of the reasons for this decline is the rise of technologies that allow investors to trade fractions of a single stock.

“Because of split trading, it doesn’t really matter what your stock price is to people. They can buy half a stock if they want,” Rawley said. “I think companies are just less interested in stock splits because it’s a hassle, it costs something and it has no real economic value.”

Rawley is skeptical of the usefulness of stock splits and sees them as an administrative adjustment rather than a strategic move of real economic significance. Still, he said the practice of stock splitting isn’t going away any time soon.

As Tesla, Apple and now Alphabet have demonstrated, some companies with very high stock prices still find stock splits a useful tool.

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