By Aniket Bose. Edited by Arjun Chandrasekar.
Overview
A fractional share is when you own less than one whole share of a company. Fractional shares allow investors to purchase stocks based on the amount the investor is able to invest. This may result in the investor ending up with a fraction of a share, a whole share, or even more than a share. Typically fractional shares aren’t available in the stock market like whole shares are, and while they have value for investors, they are very difficult for investors to sell them. Fractional shares mostly come in as the result of Dividend Reinvestment Plans, Stock Splits, and Mergers and Acquisitions.
Dividend Reinvestment Plans
Dividend reinvestment plans (DRIP) often help in creating fractional shares for investors. A dividend reinvestment plan is a plan where a dividend-offering corporation or brokerage firm allows investors to use dividend payouts. These dividend payouts are then used by investors to purchase more of the same shares. As this amount dips back into the purchase of shares, it’s no longer only subjected to whole shares. Investors that reinvest their capital gain distributions and dollar-cost averaging programs can also result in investors purchasing fractional shares. The investors do not receive dividends directly as cash, rather their dividends are directly reinvested in the underlying equity of that dividend.
Stock Splits
A stock split is a decision by a company’s board of directors to increase the number of shares that are outstanding by issuing more shares to the company’s current shareholders. For example, in a 2-for-1 stock split, an additional share is given for each share held by a shareholder. So, if a company initially had 10 million shares outstanding before the split, it will have 20 million shares outstanding after a 2-for-1 stock split. They do not always result in an even number of shares for a company. For a 3-for-2 stock split, it would create three shares for every two shares an investor owns of that company, and this would result in all the investors with an odd number of shares ending up with a fractional share after the stock split.
Mergers and Acquisitions
Mergers and acquisitions (M&As) are also another way that creates fractional shares in a company because there are companies that combine new common stock using a predetermined ratio. The predetermined ratio often results in fractional shares for the shareholders of the company. There are some brokerage firms that will intentionally split their whole shares so that they can sell fractional shares to more investors. This division of shares is most commonly seen with the stocks of Amazon and Alphabet (Google’s parent company). According to data from March 2020, Amazon shares were selling for more than $1,800 per share, and Google’s shares were selling for more than $1,100. The reason as to why companies like Amazon and Google use mergers and acquisitions to create fractional shares is because they are often the only way when individual investors can buy stocks in such companies.
Conclusion
Fractional shares, coined by the term itself, are fractions of 1 share of a company’s stock. Overall, investors are likely to witness fractional shares in three categories: DRIP, Stock Splits, and M&As.
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