What a stock split means for your portfolio and tax situation
When a stock splits, investors end up with more shares of a company, at a lower stock price. An example might be a 2:1 split, where an investor with 10 shares worth $100 each ends up with 20 shares worth $50 each after the stock split.
Apple (Nasdaq: AAPL) and Tesla (TSLA) both had stock splits on August 31. Apple split 4:1 and Tesla split 5:1, lowering their stock prices and multiplying the number of shares issued by 4 and 5 respectively.
Splits can also go the other way. The same day as AAPL and TSLA split their stocks, two other companies—Heatherdale Resources and Bam Bam Resources—did reverse splits. With a reverse stock split, instead of getting more shares at a lower price, an investor ends up with fewer shares at a higher price.
Stock splits tend to be when a stock price gets high, while reverse splits are generally done when a stock price gets low. In the case of Apple and Tesla, their stock prices were up 76% and 596% respectively this year through August 31. Heatherdale and Bam Bam, on the other hand, were both down considerably.
It is important for investors to understand that the reason for a stock split is generally quite practical. It may be easier to facilitate trading in a stock and increase liquidity if investors can trade in lots of 100 or 1,000 shares. The Toronto Stock Exchange, New York Stock Exchange and Nasdaq all have board lots of 100 shares for trading in stocks valued at over $1. Odd lots that are not multiples of 100 may be harder to fill and may be subject to higher commissions. However, commissions have decreased dramatically in recent years, particularly at discount brokerages, so another important reason for stock splits may be psychology.
Investors may prefer a stock that seems more reasonably priced and is not too high in value, so a company may do a stock split so its shares appear more affordable. To be clear, a stock split does not change the value of a company or its shares. If you cut a pumpkin pie into 6 slices or 12 slices, the size of the pie does not change.
That said, with more retail investors buying stocks at low or no commission, there may be investors who cannot or will not buy 1 share of Tesla for $2,500, but at $500 after a 5:1 split, they can become a shareholder.
Tax treatment of stock splits
From a tax perspective, investors only need to worry about stock splits in taxable non-registered accounts. This is because in a tax-free savings account (TFSA) or tax-deferred RRSP, there are generally no tax implications from buying or selling investments.