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Stock Splits & CFDs

What is a stock split (or stock dilution)?

A stock split can occur when a company issues new shares for each outstanding share. This increases the number of outstanding shares and decreases the share price. The market value of the company remains the same after a stock split.
Stock splits can also be referred to as stock dilution or stock divides.

Stock split example

The following chart shows the raw stock price of P.A.M. Transportation Services, Inc. (PTSI).

PTSI Stock Price Chart

A stock split of 2-1 occurred in mid August (doubling the number of outstanding shares). Notice the sudden, sharp drop in the PTSI share price, approximately halving from around $70 to $35 a share.

Charts of this nature can be misleading, as it is difficult for a trader to know if the sharp drop was due to a true reduction in the company's value or simply a stock split. Without a careful consideration, it seems this company is doing very badly, especially due to a shock event in August.

If we adjust the historic prices to what they would have been with today's number of outstanding shares, the picture changes.

PTSI Stock Price Chart Adjusted

The stock split is no longer evident in the chart. It is now apparent that company is doing exceptionally well, which is more consistent with reality (a chart of the market cap would show a similar trend). One downside of this second chart is that historic (pre stock split) share prices are now technically inaccurate.

Why would a company undertake a stock split?

Stock splits improve liquidity, benefiting both buyers and sellers of the stock.

How do stock splits work?

Imagine a company with

The board of directors decides to undergo a stock split by splitting each outstanding share into 2 shares. There are 3 important things to consider: An existing shareholder now owns twice the number of shares they previously owned, but each share is worth half its previous value, so the total value of the investment stays the same.

An example of how stock splits benefit investors

Stock split benefits to the existing shareholders: Consider an investor who owns a single stock in a company. The stock price is $1,000. If the investor desperately needs to raise $500 to pay his divorce lawyer’s legal bill, he might have no choice but to sell his stock, which would close his investment and leave him with $500 of spare cash. From the investor’s standpoint, he would have preferred to have kept the spare $500 invested, but now he's locked out of the investment because $500 is not enough to buy a single share valued at $1,000.

If the company underwent a stock split, splitting each outstanding share into 2 shares, the investor would have owned 2 shares at $500 each. His total investment is worth $1,000, the same as it was before. To raise $500 cash, he would simply sell one of his shares at $500 each, and keep the remaining invested. We see that stock splits provide existing shareholders flexibility in managing their existing investment in a stock.

Stock split benefits to new shareholders: more buyers will find it more affordable to purchase stock at $500 after the stock split than at $1000 before the stock split.

How do stock splits affect CFDs positions?

Since stock splits do not change the overall market capitalization of a company, the overall value of a CFD position should not be affected by a stock split. Whilst the stock price will decrease, the number shares longed or shorted will increase proportionally.

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