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Money Basics: How stock splits work

Welcome to Money Basics, Yahoo Finance’s new personal finance series offering quick explanations for some of the most important terms involving your money.

A stock split is something that occurs when a corporation increases the volume of its publicly traded shares on the market. When a stock split is initiated, it reduces the price of a stock, but the total value remains the same since the volume of shares increases proportionally. Stock splits occur in ratios, the most common being 2 to 1. For example, if a company has 100 shares outstanding traded at $10 a share and decides to split them, it will increase the volume to 200 shares and cut the price in half to $5 a share. If you own the stock, the total portfolio value remains the same.

Companies sometimes decide to split their stocks if the stock price is very high. By splitting the stock, a company can lower the price of a stock and entice new or current investors to buy more shares. While stock splits can make a company’s stock more appealing to new investors, the performance of the stock still largely depends on other factors like company performance and overall market health.

Companies also have the option to initiate something called a reverse stock split. While a regular stock split increases the number of available shares, a reverse stock split reduces available shares. Much like a regular stock split, this does not change the value of your portfolio since the value will increase relative to the number of stocks reduced. A reverse stock split is mostly based on optics of the company on the financial markets. If its stock value is suffering, a reverse stock split will help a company avoid being delisted from a major stock exchange or being removed from a stock index. Buyer beware! A reverse stock split will not solve the underlying financial problems that led the company to consolidate shares in the first place.

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• What’s the Dow Jones?
• What’s the NASDAQ?
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