Businesses divide their stocks for a variety of reasons and in a variety of ways. Here’s all you need to know about the three primary types of stock splits, how they operate, why they can be a positive or negative trigger for a company’s market value, and other crucial data.

A stock split occurs when a company’s share count increases or decreases without impacting its total worth. For example, if a company doubles its share count by giving investors one more share for every share they own, each shareholder will own twice as many shares of stock – but the total value of all outstanding shares will remain same because no additional cash was paid into the company.

The most typical reason for a corporation to split its stock is to make its shares more affordable to investors. Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) is a textbook example of a stock split driven by affordability. By 1996, the company’s original shares (now known as class A shares) had become too expensive for the average investor to own, so CEO Warren Buffett decided to create another class of shares by splitting the originals 30-for-1 in order to prevent predatory investment vehicles from being created so the public could invest in Berkshire. Berkshire’s B-class stock has since divided 50-for-1, giving these shares 1/1,500th of the equity of each Class A share.

The key motivation was once again to make the stock inexpensive. Most retail investors cannot afford the roughly $300,000 price tag of a Berkshire Hathaway Class A share. The $200 Class B shares, on the other hand, are freely available.

In order to maintain a desirable share price, some firms have split their stock on a regular basis throughout their history. Starbucks (NASDAQ: SBUX) is an excellent example. From 1993 through 2015, the corporation divided its stock six times, each time at a 2-for-1 ratio. This means that if you owned Starbucks shares prior to September 30, 1993 (the initial split) and never sold them, you would currently hold 64 Starbucks shares for every share you originally owned.

A forward split is the most common type of stock split, in which a firm expands its share count by issuing new shares to current investors. A 3-for-1 forward split, for example, would mean that if you owned 10 shares of firm XYZ before the split, you’d possess 30 shares after the split. However, the total worth of your investment would remain constant (at least in theory). As a result of the forward split, there are more outstanding shares but a lower per-share stock price, with no net gain or loss in the company’s overall market value.

Here’s a brief example: Assume you have 20 shares of a $30 stock prior to a 3-for-1 split. You would hold 60 shares of a $10 stock immediately following the split. As you can see, your overall holding value would be the same in either instance.

The most frequent stock split ratio is a 2-for-1 split (doubling the number of shares and halving the price), but 3-for-2 and 3-for-1 splits are also prevalent. However, businesses can generally utilize any split ratio that results in the desired price adjustment. For example, when the stock price of Apple (NASDAQ: AAPL) skyrocketed a few years ago, the corporation chose to conduct a 7-for-1 split.

Read Also: What Does CRT Stand for in Finance?

To manually modify your cost basis, divide the number of shares after the split by the number of shares before the split (for example, divide 1 by 2 to adjust for a 2-for-1 split). This provides you a 0.5 adjustment factor.). Then, for a 2-for-1 split, multiply your cost basis prior to the split (or the historical price you want to compensate for) by your adjustment factor (0.5 in our case).

How do stock splits create new share classes?

When a corporation utilizes a stock split to establish a completely new class of shares, this is a unique circumstance.

Alphabet (NASDAQ: GOOGL) (NASDAQ: GOOG) is a good example of this, having completed a similar split in 2012. The company, which was still known as Google at the time, decided to create a nonvoting class of stock called Class C and issue one share of the new stock for every share of existing Class A or Class B stock (the shares with more voting power owned by insiders). The split was designed to ensure that the company’s senior executives retained a majority of voting power, rather than to make the shares more accessible to average investors.

Zillow (NASDAQ: Z) (NASDAQ: ZG) made a similar move in 2015, introducing a nonvoting Class C share alongside its existing Class A and B shares, which have a voting-power structure identical to Alphabet’s stock. Investors got two shares of the new stock for each existing Class A or B share they owned, resulting in a 3-for-1 split. According to Zillow, the new stock would be used to make acquisitions and compensate executives.

Here’s what to expect in real-life scenarios. It’s business as usual between the date of the announcement and the close of trading on the day before the effective date. The stock will continue to trade in the same manner as before the announcement. The impact of the split will be visible in your brokerage account at some point between the close of trading on the day before the effective date and the market’s open on the effective date.

The increased number of shares will appear in your account on the morning of the forward stock split’s effective date, and the share price should be updated correspondingly. In the event of a reverse split, the number of shares in your account will be reduced while the share price would rise. If a new class of stock is created, this is the date you’ll find two stock positions posted in your brokerage account instead of simply one.

Final Words

To summarize, a stock split has no effect on a company’s overall market value. It is just a change in the number of shares or the structure of a company’s stock. While a stock split does not change a stock’s value, the circumstances surrounding the stock split, as well as the split-adjusted stock price, can be a good or negative catalyst.