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Stock Split Definition, Example and Quiz

A simple accounting procedure that creates no value but seems to trip up the beinner. Until now.
  1. Define - Learn the mechanics of stock splits.
  2. Context - Use stock split in a sentence.
  3. Quiz - Test yourself.
face pic by Paul Alan Davis, CFA
Updated: February 18, 2021
Spend a few minutes here if you're even a little confused about stock splits. It'll be worth it.

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Understanding Stock Splits


Stock Split is an accounting procedure initiated by the Board of Directors to change the price of a stock so it is more palatable for the intended shareholder base.

In a 2-for-1 split, the number of shares doubles and the price is cut in half.

To illustrate why no value is created, imagine splitting a pie into 8 pieces instead of 4. If a pie is worth $8, in four pieces the value is $2 per slice, and in 8 pieces the price is $1 per slice. So there is no change in value.

In what is called a reverse share split the opposite is the case. For example, a 1-for-2 split would decrease the number of shares by half and double the price. Management might want to enact this if their share price is too low, as happened with Citigroup stock after the Financial Crisis in 2008-2009.

Some active managers interpret stock splits as evidence of confidence from management and expect positive abnormal returns after the announcement of the split, but this point is debated in academic circles. There is some near-term evidence of outperformance, but over long periods of time these disappear.

Synonym: split

For context, in a way, understanding the dynamics of stock splits is easy, and in my mind it is like understanding conjugations like "it's" versus "its" and "we're" versus "were", sometimes you have to think about it, but using the wrong one is a credibility killer. So make sure you know the takeaways about stock splits.

In a Sentence

Doc:  Tom, will you explain to the class the concept of a stock split?
Tom:  A whole pizza pie sells for $16, or two halves for 8 bucks each.


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Video Script

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Click box for answer.

A stock with a higher price is more expensive. | True or False?

False. Expensive is a valuation concept, price doesn't matter because you can always change the number of shares.

A $5 stock that goes through a 1-for-5 reverse share split would trade at what price? | $1 or $10 or $25 or $50?


Questions or Comments?

Still unclear on Stock Splits? Check out the Quant 101 tutorial series on financial modeling in Excel, particularly Calculate Monthly Returns on Stocks in Excel.

Related Terms

Our trained humans found other terms in the category corporate actions you may find helpful.

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