Ordinary splits occur when a publicly held company distributes more stock to holders of existing stock. A stock split, say 2-for-1, is when a company simply issues one additional share for every one outstanding. After the split, there will be two shares for every one pre-split share. (So it is called a “2-for-1 split.”) If the stock was at $50 per share, after the split, each share is worth $25, because the company’s net assets didn’t increase, only the number of outstanding shares.
Sometimes an ordinary split is referred to as a percent. A 2:1 split is a 100% stock split (or 100% stock dividend). A 50% split would be a 3:2 split (or 50% stock dividend). Each stock holder will get 1 more share of stock for every 2 shares owned.
Reverse splits occur when a company wants to raise the price of their stock, so it no longer looks like a “penny stock” but looks more like a self-respecting stock. Or they might want to conduct a massive reverse split to eliminate small holders. If a $1 stock is split 1:10 the new shares will be worth $10. Holders will have to trade in their 10 Old Shares to receive 1 New Share.
Theoretically a stock split is a non-event. The fraction of the company that each share represents is reduced, but each stockholder is given enough shares so that his or her total fraction of the company owned remains the same. On the day of the split, the value of the stock is also adjusted so that the total capitalization of the company remains the same.
In practice, an ordinary split often drives the new price per share up, as more of the public is attracted by the lower price. A company might split when it feels its per-share price has risen beyond what an individual investor is willing to pay, particularly since they are usually bought and sold in 100’s. They may wish to attract individuals to stabilize the price, as institutional investors buy and sell more often than individuals.
After a split, shareholders will need to recalculate their cost basis for the newly split shares. (Actually, this need not be done until the shares are sold, but in the interest of good record-keeping etc., this seems like a good place to discuss the issue.) Recalculating the cost basis is usually trivial. The shareholder’s cost has not changed at all; it’s the same amount of money paid for the original block of shares, including commissions. The new cost per share is simply the total cost divided by the new share count.
Recalculating the cost basis only becomes complicated when a fractional number of shares is involved. For example, an investor who had 33 shares would have 49.5 shares following a 3:2 split. The short answer for calculating cost basis when a fractional share enters the picture is .. it depends. If the shares are in some sort of dividend reinvestment plan, the plan will credit the account holder with 49 1/2 shares. Fractional shares are very common in these sort of accounts. But if not, the company could do any of the following:
- Issue fractional certificates (extremely unusual).
- Round up, and give the shareholder 50 shares (rare).
- Round down, and give the shareholder 49 shares. This happens among penny stocks from time to time.
- Sell the fractional share and send the shareholder a check for its value (perhaps taking a small fee, perhaps not). This is far and away the most common method for handling fractional shares following a split.
Accounting for the cost basis of the first three methods is trivial. However, accounting for the most common case, the last one, is the most complicated of the options.
Let’s continue with the example from above: 33 shares that split 3:2. The original 33 shares and the post-split 49.5 shares have exactly the same cost basis. To make it easy, assume the 33 shares cost a total of $495. So the 49.5 post-split shares have a cost basis of $10 per share, or $5 for the half share that is sold. The cash received “in lieu of” the fractional share is the sales price of that fractional share. Say the company sent along $8 for it.
The capital gain (long term or short, depending on the holding period of the original shares) is $8 – $5 = $3. To account for this properly, the following would be required.
- File a schedule D listing 0.5 shares XYZ Corp and use the original acquisition date and date it was converted to cash and sold; usually the distribution date of the split but the company will tell you. Use $5 as cost basis and $8 as sales price and voila, there is a $3 gain to declare.
- Reduce the cost basis of the remaining 49 shares by the cost of the fractional share sold. ($5)
- The cost basis of the $49 shares becomes $495 – $5 = $490 (still $10 per share).
Hopefully the preceding discussion will help with recalculating the cost basis of shares following a split.
Now we’ll go into some of the mechanics of splitting stock. The average investor doesn’t have to care about any of this, because the exchanges have splits covered – there is absolutely no danger of an investor missing out on the split shares, no matter when he or she buys shares that will split. The rest of this article is meant for those people who want to understand every detail.
Often a split is announced long before the effective date of the split, along with the “record date.” Shareholders of record on the record date will receive the split shares on the effective date (distribution date). Sometimes the split stock begins trading as “when issued” on or about the record date. The newspaper listing will show both the pre- split stock as well as the when-issued split stock with the suffix “wi.” (Stock dividends of 10% or less will generally not trade wi.)
Some companies distribute split shares just before the market opens on the distribution date, and others distribute at close of business that day, so there’s not one single rule about the date on which the price is adjusted. It can be the day of distribution if done before the market opens or could be the next day.
For people who really are interested, here is what happens when a person buys between the day after the T-3 date to be holder of record, and the distribution date. (Aside: after a stock is traded on some date “T”, the trade takes 3 days to settle. So to become a share holder of record on a certain date, you have to trade (i.e., buy) the shares 3 days before that date. That’s what the shorthand notation “T-3” above means.) Remember that the holder of record on the record date will get the stock dividend. And of course the price doesn’t get adjusted until the distribution date. So let’s cover the case where a trade occurs in between these dates.
- The buyer pays the pre-split price, and the trade has a “Due Bill” atttached. The due bill means the buyer is due the split shares when they are issued. Sometimes the buyer’s confirmation slip will have “due bill” information on it.
- In theory, on the distribution date, the split shares go to the holder of record, but that person has sold the shares to the buyer, and a due bill is attached to the sale.
- So in theory, on the distribution date, the company delivers the split shares to the holder of record. But because of the due bill, the seller’s broker delivers on the due bill, and delivers the seller’s newly received split shares to the buyer’s broker, who ultimately delivers them to the buyer.
The fingers never left the hand, the hand is quicker than the eye, and magic happens. In practice no one really sees any of this take place.
In some cases, the company may request that its stock be traded at the post-split price during this interval, or the market itself might decide to list the post-split stock for trading. In such cases, the due bills themselves are traded, and are called “when issued” or for spinoff stock, “when distributed” stock. The stock symbol in the financial columns will show this with a “-wi” or “-wd” suffix. But in most cases it isn’t worthwhile to do this.
Article Credits:
Contributed-By: Aaron Schindler, E. Green, Art Kamlet