Many publicly traded companies initiate stock splits or buybacks based on the market and the performance of their company’s stock. Investors who currently hold those stocks generally don’t have to take any action when a stock splits or a company engages in a stock buyback. Whether these changes will have a positive or negative impact on your holdings depends on the situation, but they are often viewed as opportunities for investors.
What Is a Stock Buyback?
A stock buyback is when a company buys a large number of their own shares. They then either cancel these shares or transform them into treasury shares. You can see the effects of a buyback on a company’s “outstanding shares.”
For example, if a company with a million outstanding shares initiates a 100,000-share buyback, they will only have 900,000 outstanding shares left available. This has a direct impact on the book value per share (BVPS). BVPS can be determined by subtracting preferred stock valuation from stockholder equity and then dividing the difference by the number of outstanding shares.
$10,000,000 stockholder equity minus $2,000,000 of preferred stock divided by 1,000,000 shares would equal an $8 BVPS.
$10,000,000 stockholder equity minus $2,000,000 of preferred stock divided by 900,000 shares would equal an $8.89 BVPS.
What Is a Stock Split?
A stock split or stock divide does the opposite of a buyback. A common example is a 2-for-1 stock split wherein every single share is now two shares. If you have 50 shares of a company that does a 2-for-1 stock split, you’ll immediately have 100 shares, each of which will be worth half of what the full share was worth. If your 50 shares are worth $500 ($10 per share) your 100 shares will still be worth $500 ($5 per share).
Increased trading liquidity is often a motivating factor for companies who enact stock splits since a single share becomes more affordable. An investor who might not buy at $500 per share might be less reticent at $100 per share after a 5-for-1 stock split.
A company may be tempted to engage in stock splitting if a single share of their stock costs significantly more than competitors in their sector. This perceived affordability may also result in a temporary boost in stock price since more cost-conscious investors will see an opportunity to buy in.
What Is a Reverse Stock Split?
A reverse stock split is essentially the same procedure but in reverse. If you had a $500 investment in 50 shares ($10 per share) in a company, and the company engages a 1-for-2 reverse stock split, you would have a $500 investment ($20 per share) with 25 shares.
Many stock exchanges have a minimum price per share requirements for listed companies. Reverse stock splits are sometimes used if a company’s share value is decreasing, and they are at risk of being delisted from their exchange.
Companies may also engage in a reverse stock split to discourage speculative trading, which becomes riskier with a higher share price. This may have the added benefit of reducing a stock’s volatility.
If you have an uneven number of shares and a stock does a reverse split, you may either be given a fractional share or cash in the value of the fractional share you would have received.
Which Is Better for Investors, a Stock Split or a Stock Buyback?
Stock splits may initiate greater interest in a stock, which could be good news for current investors. A stock buyback may also temporarily increase the value of each share since there will be fewer shares available to trade.
A company’s motivations can have a significant impact on how a buyback or split is viewed and the long-term effect it has on a stock’s valuation. A buyback may be used to improve the appearance of some metrics even though it doesn’t impact how a business is operated. Investors aren’t ignorant, and the market may see through efforts of manipulation, which could have long-term negative consequences for a company’s valuation.
Whether a stock split, reverse split or buyback is good or bad for investors depends on the company, their industry and market variables. If you’re concerned about company decisions that may affect your holdings, it may be in your best interest to consult with an investment manager about your options.
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