THE BASICS OF INVESTING WITH RYAN JAMES: STOCK SPLITS & NET WORTH

By Ryan James

Stock Splits

There are two types of stock splits—a forward split and a reverse split.

A forward split is when a company increases the total number of outstanding shares. A 2:1 (or a 2-for-1) split, means every shareholders’ number of shares will be doubled. Although shareholders now have twice as many shares, each share’s value is halved. Therefore, the total value of the stock remains constant. A forward split will allow investors to buy stock at a lower share price. This could be beneficial to companies with higher stock prices that have risen significantly.

A reverse split is the opposite of a forward split. This less utilized form of stock splits is used to decrease the total number of outstanding shares and increase the price per share. This ratio is inversed, being 1:2 instead of 2:1.

Unless investors have a strongly positive or negative reaction to the news of a stock split, this event has no impact on the company’s market cap. An example of a company that has never performed a stock split is Berkshire Hathaway Class A (NYSE: BRK.A) which has a share price of over $450,000, the most expensive of any stock.

“I own sixteen percent of Amazon. Amazon is worth roughly a trillion dollars. That means that what we have built over twenty years—we have built $840 billion of wealth for other people.” — Jeff Bezos, CEO and founder of Amazon.com et al, at the Economic Club of Washington, D.C., 2018

Fractional Shares

Fractional shares are parts of shares, usually denoted in decimal form, that are less than one whole share.

Most electronic trading platforms will not allow traders to purchase fractional shares, so the only way to obtain them is through dividend reinvestment programs. This process allows investors to automatically reinvest dividends back into the stock of the issuing company.

Some platforms (e.g. Charles Schwab and Robinhood), however, allow investors to purchase “stock slices.” These are typically purchased by a dollar amount rather than by the share, resulting in fractional shares rather than whole ones.

The back office deals with fractional shares. Traders who would like to sell all of their shares in a company’s stock would do so differently if they own fractional shares. Instead of all shares going on the market to be sold immediately, only whole shares would do so; fractional shares would remain with the back office to be sold later.

Net Worth

Net worth is what a person owns minus what they owe. The formula for this is net worth = assets – liabilities. How much someone is “worth” is determined by this. According to Investopedia, “an asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit” (real estate, stocks, bonds, cash, etc.), and “a liability (generally speaking) is something that is owed to somebody else” (a car, bank debt, etc.).

An individual with a high net worth does not necessarily have high cash wealth, meaning they own a lot of money in assets but not in actual cash. Many of the wealthiest individuals in the world are represented by this. They typically own large stakes in their companies.

Take Elon Musk, for example. Musk owns about 175 million shares of Tesla stock, per Barrons, worth about $185 billion at the time of the writing of this issue (this is on top of the private shares he holds for his many other companies).

Bottom Line

A company can change the quantity of outstanding shares using stock splits. Fractional shares are treated differently from whole shares. Net worth is what an individual owes subtracted from what that person owns, and it is not synonymous with income, the money an individual receives.

Disclosure: All statements and opinions expressed in this article are objective and my own. I am not a financial advisor. I do not recommend the trade or use of any particular stocks or services. I acknowledge the risks of investing.