Do you own a stock that has split, or might? Well, it seems that the second half of 2020 has been a popular time for large corporations to announce stock splits - including companies like Apple, Tesla and McCormick. This can be great news for eager investors looking to add these market titans to their portfolio, but who may have not been able to in the past.
Below is a brief primer on stock splits, and what they mean for potential investors, current investors and the companies themselves.
1. What Are Stock Splits?
Simply put, a stock split occurs when a company decides to split its current shares into more shares. This does not affect the total value of an investors' shares, it simply creates more of them. For instance, if one share at $100 was split into two shares, each share would be worth $50 - still equaling $100 total.
2. The Math Behind Stock Splits
Think about a pizza (stick with us here). Say you have a normal, large pepperoni pizza with eight slices. Each of these slices makes up a share of a company. If that company decides to do a stock split, that means that each slice of pizza will be further divided.
If two of those slices are yours and a 2-for-1 stock split is announced, those two slices will be split into 4 smaller total slices. The actual amount of pizza that’s yours has not changed, it’s simply been divided up even further. This allows less-hungry investors to grab a smaller slice of pizza, whereas before they’d have to take a whole slice if they wanted in on the pizza.
Stock splits can occur in a number of different ways: 2-for-1, 3-for-1 and 3-for-2. While the math can feel complicated, the stock split ratios are fairly self-explanatory:
2-for-1: If you owned one share before the split, now you own two.
3-for-1: If you owned one share before the split, now you own three.
3-for-2: For every two shares you owned before the split, you now own three.
3. Who Benefits From Stock Splits?
Stock splits can be an appealing investment option for those who typically have smaller capital to invest with. They make it possible for interested investors to buy stocks from popular companies whose stock values have skyrocketed over time. You may not have been able to invest in a company whose stock prices sit at around $600 per share, but when the stock is split and you can obtain a few at, say, $100 a share - this may become more doable.
The amount of shares you own will increase, but their worth will decrease proportionately - meaning a stock split will not affect your the total value of your current holdings. For example, if you owned one share that was worth $200 and a 2-for-1 stock split occurs, you now own two shares worth $100 each- for a total value of $200.
However, stock splits have the potential to be good news for current investors - as it indicates the company is opening the door for new investors, meaning it could be a push that drives the stock prices up. This, of course, is not guaranteed, but the potential is there for current investors to get excited.
And, of course, the company that decides to split their stocks has done so because they find it’ll likely be beneficial for their company. Here’s why:
As a company grows, releases new products and continues to profit, its stock values rise. And while this is good news for investors and the company alike, it’s possible that high stock prices begin to have a negative impact on the company’s market liquidity. Stock prices that grow too high appear to become less-attainable for the everyday investor, meaning fewer people are choosing to invest in that company. In reality, however, you can invest the same dollars amount and simply receive less shares for your investment. The pursuant math of a gain or loss in percentage amounts would still be the same either way, so the stock split really shouldn't matter. But since so many people don't understand this, the theory behind the value can become somewhat of a reality and it often does, as we've seen recently with #Tesla.
Stock splits can also be appealing for companies, because they allow more investors to buy shares at more affordable prices. Additionally, the announcement of a stock split can often cause excitement amongst new potential investors, drumming up interest and (potentially) boosting stock values. A recent NASDAQ report indicated that simply announcing a large cap stock split increased stock value by 2.5 percent.1
Stock splits can be an exciting opportunity that makes pricey stock shares more attainable for the everyday investor. If you’re considering adding stock splits to your portfolio, make sure to check in with your investment advisor first. He or she can help you determine whether this may be a beneficial, long-term move toward your larger financial goals.
Owning Stock-Split Stocks in an a Non-IRA vs an IRA vs a Roth IRA
Something that can be a savvy move to consider if you believe a stock price may increase after a stock split is where to own the stock. This is where the term asset "location" can have a bigger impact than asset "allocation". Because rising stock is nice to see on your paper or digital statement, but depending on where you own it, the total value shown may not be entirely yours. Here are few things to remember as to where to own a stock you believe will rally after a stock-split:
1) Non-IRA - This includes an account you may own as an "individual" or a joint-owner-with-rights-of-survivorship (JTWROS) or possibly with a Living Trust. A stock split here will not be taxable, but if the price climbs, you may still owe taxes at the capital gains tax rates. Since capital gains tax rates are generally more favorable than ordinary income tax rates, this may be a good place to own a stock you expect to appreciate after the split. If you are wrong and the stock drops in value, you may also end up with a loss you may be able to use for tax purposes the same year, or in the future.
2) Traditional IRA - Recall this account hasn't been taxed yet. So a win in stock price appreciation may come at the expense of higher taxes in the future, especially if ordinary income tax rates climb higher. What can you do? Consider transferring the shares of the stock you expect to split to a Roth IRA. You can do so "in-kind" which means that you can transfer the shares without selling them to avoid risking the chance of the price climbing in the midst of the move. Ideally then, the appreciated price attributable to the stock split will occur on a tax-free basis since neither capital gains nor distributions from Roth IRAs are subject to income tax. Of course, there is no free lunch, you still need to pay the tax based upon the valuation of the shares you use to transfer from the Traditional IRA to the Roth IRA as a Roth IRA Conversion. But you will eventually need to do that anyhow when you take the money out for spending. At least this way, one-hundred percent of what you take out of the account will be yours and not subject to an unknown future income tax liability.
3) Roth IRA - As you likely already gathered if you read option two above, is that the Roth IRA, in our opinion, is likely the best place to own shares of a stock that you expect to appreciate. All of the gains, income, and distributions will be tax-free, thus allowing you the comfort and confidence that the value you see on your statement is all yours, not partially yours along with your least favorite uncle, Uncle Sam. If you don't own a Roth IRA, this a great reason to get one started. Using a Roth IRA Conversion strategy is a simple yet savvy way to get more wealth into a Roth IRA faster than by merely making annual contributions that are limited depending upon your age. The Roth IRA is also a great place to own stock you think you may never use. Perhaps this is why you are taking the additional risk of buying a single stock in the first place. If so, the eventual use of the appreciated shares pursuant to a stock-split in the Roth IRA is not only tax-free for you. It is also tax-free to your beneficiaries. Remember, it is not just what you own and how well it does that matters, but also where you own it and what you keep in the end.
By Christian Cordoba
CERTIFIED FINANCIAL PLANNER™
& Founder of California Retirement Advisors
This content is developed from sources believed to be providing accurate information, and provided by #CaliforniaRetirementAdvisors. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.
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