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A Visual Guide to Stock Splits

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visual guide to stock splits

A Visual Guide to Stock Splits

Imagine a shop window containing large pieces of cheese.

If the value of that cheese rises over time, the price may move beyond what the majority of people are willing to pay. This presents a problem as the store wants to continue selling cheese, and people still want to eat it.

The obvious solution is to divide the cheese into smaller pieces. That way, more people can once again afford to buy portions of it, and those who want more can simply buy more of the smaller pieces.

cheese and stock splits

The total volume of the cheese is still worth the same amount, it’s only the portion size that changed. As the infographic above by StocksToTrade demonstrates, the same concept applies to stock splits.

Like wheels of cheese, stocks can be split a number of different ways. Some of the more common splits are 2-for-1, 3-for-1, and 3-for-2. Less common splits can take place as well, such as when Apple increased its outstanding shares by a 7-to-1 ratio in 2014.

Why Companies Do Stock Splits

Of course, stocks aren’t cheese.

The real world of the financial markets, driven by macro trends and animal spirits, is more complex than items in a shop window.

If companies want their stock price to continue rising, why would they want to split it, effectively lowering the price? Here are a some specific reasons why:

1. Liquidity
As our cheese example illustrated, stocks can sometimes see price appreciation to the point where they are no longer accessible to a wide range of investors. Splitting the stock (i.e. making an individual share cheaper) is an effective way of increasing the total number of investors who can purchase shares.

2. Sending a Message
In many cases, announcing a stock split is a harbinger of prosperity for a company. Nasdaq found that companies that split their stock outperformed the market. This is likely due to investor excitement and the fact that companies often split their stock as they approach periods of growth.

3. Reducing Capital Costs
Stocks with prices that are too high have spreads that are wider than similar stocks. When spreads—the difference between the bid and offer—are too large, they eats into investor returns.

4. Meeting Index Criteria
There are specific instances when a company may want to adjust its share price to meet certain index requirements.

One example is the Dow Jones Industrial Average (DJIA), the well-known 30-stock benchmark. The Dow is considered a price-weighted index, which means that the higher a company’s stock price, the more weight and influence it has within the index. Shortly after Apple conducted its 7-to-1 stock split in 2014, dropping the share price from about $650 to $90, the company was added to the DJIA.

On the flip side, a company might decide to pursue a reverse stock split. This takes the existing amount of shares held by investors and replaces them with fewer shares at a higher price. Aside from the general stigma associated with a lower share price, companies need to keep the price above a certain threshold or face the possibility of being delisted from an exchange.

Stock Splits Happen, but are not Inevitable

Alphabet will become the most recent high profile company to split their stock in early 2022. The company’s 20-for-1 stock split aims to make the share price more accessible to retail investors dropping the price from approximately $2,750 to $140 per share.

Conversely, Berkshire Hathaway has famously never split its stock. As a result, a single share of BRK.A is worth over $470,000. Berkshire Hathaway’s legendary founder, Warren Buffett, reasons that splitting the stock would run counter to his buy-and-hold investment philosophy.

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Investor Education

Visualized: A Step-by-Step Guide to Tax-Loss Harvesting

In Canada, tax-loss harvesting allows investors to turn losses into tax savings. This graphic breaks down how it works in four simple steps.

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An illustrative graphic showing part of the steps in tax-loss harvesting, including selling a $50,000 investment with a $10,000 loss.

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The following content is sponsored by Fidelity Investments

A Step-by-Step Guide to Tax-Loss Harvesting

Market ups and downs can be unnerving, but the good news is that tax-loss harvesting allows investors in Canada to capture tax savings when their portfolio drops in value.

While it sounds complicated, a tax-loss harvesting strategy is actually fairly straightforward. An investor can use capital losses to offset capital gains found elsewhere in their portfolio, leading to a lower tax bill. While there are important conditions to keep in mind, investors can use this strategy to enhance portfolio returns over time by reinvesting these tax savings.

This graphic from Fidelity Investments shows how tax-loss harvesting works and why it may improve tax efficiency in an investor’s portfolio.

Breaking It Down

Consider a person who invested $50,000 in a mutual fund held in a non-registered account that has dropped by $10,000 in value. To help minimize losses, they took the following steps in a tax-loss harvesting strategy.

For the sake of this example, taxes are based on the maximum federal rate and the average maximum provincial tax rate.

  1. Sold investment with a $10,000 loss
  2. Invested $40,000 into a different mutual fund
  3. Used the $10,000 capital loss to offset capital gains realized elsewhere in the non-registered portfolio
  4. Achieved up to $2,550 in tax savings

The investor realized as much as $2,550 in tax savings by utilizing a $10,000 loss against a $10,000 capital gain. Without tax-loss harvesting, this $10,000 capital gain would be taxed at a 50% capital gains inclusion rate ($10,000 X 50% = $5,000). This $5,000 in applicable gains is then taxed at a 51% combined federal and provincial tax rate ($5,000 X 51% = $2,550 in taxes owed).

In contrast, by using tax-loss harvesting, the investor would have achieved up to $2,550 in tax savings.

What’s more, you can reinvest your tax savings over each year—which may help boost portfolio returns over time if the new investment increases in value.

Tax-Loss Harvesting Tips

With a tax-loss harvesting strategy, here are some key tips and considerations to keep in mind:

  • Investment Timeline: A capital loss can be used to offset capital gains not only in the current year, but in the three years prior and/or any year indefinitely in the future.
  • New Investment Type: After selling an investment that’s dropped in value, it’s important to buy a different investment to avoid triggering the ‘superficial loss rule’. Investors can aim to choose an investment with similar long-term returns.
  • Plan for Year-End: In order to achieve a capital loss, plan to sell an investment at least two to three days before the year’s final trading day so the investment settles before year-end.

Together, these tips can help investors strategically execute a tax-loss harvesting strategy.

Tax Made Easier

During volatile markets, investors can seize the opportunity to turn losses into tax savings using tax-loss harvesting as a key tool to help generate higher after-tax returns.

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Explore Fidelity’s tax calculator to discover tax-saving opportunities.

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