Q: Can you explain what it means when a stock splits? What about a stock spin-off? Is that different? And are these things good or bad for an investor?
A: Let’s tackle each one of these separately since stock splits and stock spin-offs are two entirely different transactions.
A stock split will typically occur when a stock has seen a significant increase in price. For example, in August of 2020 Apple experienced a 4 for 1 stock split. On Friday August 28th the stock closed at $499.87. On Monday August 31st the stock opened at $124.81. If you were an investor who owned 100 shares on Friday, you woke up Monday owning 400 shares. As an investor you have four times the shares at one fourth the price. You should have the same amount of money in your account from one day to the next. So why do companies split their stock?
The (much debated) theory is that by having a lower share price it makes it easier for investors to buy your stock. The theory is that the increased trading volume and liquidity will lead the value of your stock higher. From a purely psychological context, splitting your stock can signal to the market that the stock has performed well and that management expects that it will continue to perform well. The discussion of stock splits would not be complete without mentioning a high profile dissenting opinion on the value of stock splits, Warren Buffett. Warren Buffett has long refused to split the stock of his company, Berkshire Hathaway. A single share of Berkshire stock is priced around $360,000!
A stock spin-off will usually occur when investors feel that a particular business could be better run as a stand-alone company. You can think of it like the opposite of a merger. For example, in 2015 Ebay decided to spin-off PayPal into its own separate company. If you had been an investor in Ebay, you would have received some PayPal shares as part of the deal. Of course the ultimate goal is to unlock the value in the company being spun off and allow both companies to focus on a more narrow objective. In this particular example it appears that the spin-off was a success for both companies.