Buzz
Over the past 30 years, since Amazon started as a modest online bookstore, it has become a force in nearly every area of our lives. It’s not only a retailer and grocery store, but also a media streaming service, movie production studio, cloud computing giant, and a major employer. This growth has contributed to a market capitalization of around $1.6 trillion, making Amazon the fifth-largest company in the world, trailing behind Apple, Saudi Aramco, Microsoft, and Google. That’s a massive amount of money, and if you bought Amazon stock two decades ago, you're likely very pleased with your investments now.
This is why Amazon’s announcement of a 20-for-1 stock split recently created such a stir. If you're among those whose understanding of the stock market can be summed up as “it’s complicated,” and the fluctuating value of your 401k fund seems like a mystery, you may wonder why this news got so much attention. Why should it matter, and what exactly is a “stock split”?
The distinction between a stock split and a reverse stock split
Stock splits are fairly easy to grasp. When a company performs a stock split, it increases the number of shares while proportionally reducing the value of each individual share. For example, if your company is split into ten shares worth $1 each, it could be restructured into 20 shares, each valued at $0.50. The total value of the stock doesn’t change; it just creates more shares. So, if you owned two shares worth $2 before, you now own four shares worth the same total of $2.
A reverse stock split is essentially the opposite process: the company reduces the number of shares, raising the price of each individual share without affecting the total company value. For instance, if you had 20 shares priced at $0.50 each and the company reversed the split to 10 shares, each of those shares would now be worth $1.
Stock splits usually occur in smaller ratios like 2-for-1 or 3-for-1. This is one of the reasons why Amazon’s 20-for-1 split made headlines—it’s a much larger ratio than usual. Additionally, Amazon is combining the split with a $10 billion stock buyback, which will slightly increase the value of the new shares.
Why do companies split their stocks?
Companies often split their stock when the price becomes too high. Investors typically prefer to buy stocks in lots of 100 shares. When the price of a stock becomes too expensive, smaller investors can’t afford to buy them. Amazon’s stock, for instance, has been priced around $3,000 for some time, which is quite costly. A standard 100-share lot would run about $300,000, excluding fees, which is out of reach for many investors. After the 20-for-1 split this summer, the share price will drop to approximately $150, making a 100-share lot much more affordable at around $15,000.
This can make the stock more appealing to stock market indices like the Dow Jones Industrial Average, which tracks 30 major companies to gauge the overall health of the stock market. Since the DJIA is price-weighted (meaning that a higher-priced stock has a greater impact on the index’s movement), Amazon wouldn’t be included at a $3,000 stock price—but it could be at $150. A stock split also enhances the stock’s liquidity, making it easier to sell, which in turn boosts its attractiveness to investors. After all, if your stock is so expensive that you can’t quickly sell it when you need cash, it becomes less useful as an asset.
A stock split also makes it easier for Amazon to offer stock options to its employees. When the stock price is very high, it becomes difficult to offer modest stock grants in the $5,000 to $10,000 range. A lower share price provides more flexibility in making such offers.
A reverse stock split is used for the opposite purpose: If a company feels its stock is becoming too inexpensive (possibly risking delisting from an exchange), a reverse split increases the value of each share. There is also a strategy called reverse/forward stock splitting, where a company first performs a reverse split—forcing some stockholders with small holdings to sell their shares—then does a regular stock split to restore the stock price, increasing the number of shares held by the remaining shareholders. It’s a method of consolidating ownership.
Stock splits, whether in the form of a regular or reverse split, are simple management tactics—no one gains or loses anything in the immediate moment, but the way the stock is perceived and traded changes moving forward. Is now a good time to buy Amazon stock? Possibly—but that’s a question best directed to your broker.
