Basics

• Stock splits are expressed in a ratio, such as 2:1. In a 2:1 stock split, the most common type, every stockholder gets two shares for every share he owns. The price of the shares is adjusted accordingly.
  
  Suppose an investor owns 100 shares of Company XYZ common stock, which currently trades at $120 per share. The company announces a 2:1 stock split. The investor receives two shares for every one share held. And the stock price is adjusted to $60 per share.
  
  In this sense, it has no effect on the value of the portfolio. The company doubled the number of shares outstanding but has the same market capitalization.
  
  

Significance

• Companies split their stocks to make their stocks cheaper for potential buyers. Some people view a stock split as a signal of management confidence in the future performance of the company. For example, if a stock were trading at $200 per share, some investors might shy away from purchasing it. To avoid this, management might consider a 2:1 or 3:1 stock split. The lower-priced stock will appear more affordable to some investors, thus increasing buying activity.
  
  The Apple Corp. has had three 2:1 stock splits in its history, the last of which was in February 2005.
  
  

Advantages

• Some stock market experts believe that companies who have a stock split tend to do better on average after the announcement. When a company announces a stock split, some speculators will rush to purchase that stock, or an option on that stock, with the idea that the stock price is going to increase after the split. In reality, though, a stock split is a neutral event. Nothing has changed except the perception of investors regarding the affordability of that stock.
  
  

Drawbacks

• Since a stock split is a neutral event, there aren't any drawbacks. There is something called a reverse stock split, which can be a sign of trouble.
  
  A reverse stock split is when a company reduces by a ratio of 1:2 the number of shares outstanding, thus doubling the price of its stock. Companies only do this if their stock price is low, less than $3 per share, for example.
  
  A reverse stock split can be bad because it indicates that the stock price has dropped so low that it is unappealing to new investors and the company is attempting to make it look better through artificial means.
  
  

Other Information

• Stock splits can also be 3:1, 4:1, 3:2, 5:1 or any other ratio.
  
  There are no tax consequences from a stock split.