How Do Stock Splits Affect Dividends?

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When a company splits its stock, the number of outstanding shares owned by investors increases. For example, if you own 50 shares in a company that completes a 2-for-1 split, you'll be issued 50 additional shares. This affects the share price, as well as the dividend paid by each share of stock.

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Why companies choose to split their stock

There are several possible company-specific reasons a stock split could be a good idea, but a primary motivation in most cases is a desire to maintain a stock price in a certain range. This can help keep the stock affordable to investors.

As an extreme example, let's say Berkshire Hathaway had never decided to split its stock and issue Class B shares. Well, the original Class A Berkshire Hathaway shares are worth more than $280,000 -- out of the realm of affordability for most investors. The Class B shares are trading for just over $187 as of this writing, opening up the stock to millions of potential investors.

While a stock split doesn't cause the value of a company's intrinsic value to rise, it can make the stock accessible to more investors, and often increase demand, which can push the stock price higher.

What stock splits mean to your dividends

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Simply put, a stock's dividend per share will be reduced as a result of a stock split, but the total amount of dividends paid doesn't change.

For example, let's say a company pays a $1 quarterly dividend for each of its 10 million outstanding shares. If the company splits its stock 2-for-1, it will now have 20 million outstanding shares, each of which pay a $0.50 dividend. So if I owned 100 shares pre-split, I would receive a total of $100 as a quarterly dividend payment, the same as I would continue to receive after the split.

If a stock splits after a dividend record date has passed, technically speaking, the newly created shares won't pay the dividend and the entire payment will come from the pre-existing shares. However, the overall effect is still the same -- the total dividend paid doesn't change

The bottom line on stock splits

Stock splits don't change anything about an underlying business or its valuation -- they simply multiply the number of shares and make each share worth proportionally less. Therefore, shareholders will still receive the same total dividend payment, but it will be in the form of less money coming from each of a greater number of shares.

The same logic applies to other investments and metrics related to a stock's price. For example, if you own options to buy a certain stock for $100 per share at any time before 2019, and the stock undergoes 2-for-1 split in 2017, you'll now have options to buy twice as many shares for $50. If a company is projected to earn $2 per share before a 2-for-1 split, it is then projected to earn $1 per share, assuming nothing fundamentally changed with the business.

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Matthew Frankel owns shares of Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.