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Tommy Douziech

Analyst
Tommy Douziech is above all a GARP investor who enjoys exploiting market inefficiencies on qualitative stocks with a nice margin of safety. Specialist in marketing and passionate about finance, this market analyst has made a place for himself at Marketscreener, juggling between long-term value investments, trading strategies and market psychology as he sees fit.

The hidden side of fractional shares

06/09/2022 | 11:39am EDT

Many companies have stocks priced in the hundreds or thousands of dollars, making it difficult to buy them or to buy them regularly as part of a DCA (Dollar Cost Averaging) approach to investing. To remedy this, many brokers offer fractional shares in order to democratize the stock market to everyone, regardless of the size of their portfolio. But most of them fail to tell you what these fractional shares are really about. Let's find out together.

Some online trading platforms offer to invest in fractional shares, especially shares of large American technology companies with a high unit value (several thousand dollars). The idea, aimed at popularizing stock market investing among individuals with "limited means" to build a portfolio, is quite appealing. But these offers do not always explain very clearly what you are investing in. Let's take a closer look.

Under the name "fractional shares", there are actually several types of offers on the market and it is important to read the commercial and regulatory documentation carefully to understand what you are being offered to buy.

The important questions are:

What is the exact nature of this product, do I understand it, what are my rights and in particular, do I own the stock?

The good guys: Some offers allow you to actually buy fractions of shares, notably through a monthly investment program, and to automatically consolidate the fractions into "whole" shares as soon as possible. This is nothing more or less than investing in shares (as is the case with Trade Republic, for example). But you need to make sure you understand the rules of fractional share grouping.

The bad guys: Other offers are actually financial securities or financial contracts (derivatives) whose value fluctuates based on the price movement of the underlying asset, i.e. the stock you think you're buying a fraction of. You are not the owner of the stock, but only of a financial instrument that replicates the performance of the stock. You are in fact a creditor of the issuer of this financial instrument.

Almost all brokerage services that offer you fractional shares are in the second category. They sell you derivatives or certificates. You are not the owner and therefore cannot make shareholder decisions. Your rights are reduced, and your risk increases. You are in effect bound to the contract with that issuer, it has value only as long as your issuer is alive and acknowledges the existence of that contract.

Even if fractional shares allow on paper to offer access to many companies whose shares are too high for many individuals wishing to invest in the stock market, you must remain vigilant as to what you are really being offered. Those who had not seen these subtleties may finally wonder what the difference is with a stock split.

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Fractional shares vs stock split

Stock splits happens when the listed company itself decides to split its shares (by 2, by 4, by 10, by 100, etc.) when the unit value becomes too high to remain accessible to the general public. I am thinking in particular of Amazon, which recently split its shares in 20, going from $2460 to $123, or Alphabet, which will do so in July 2022 and whose current price is $2342. It then proceeds to a "stock split", a division of the so-called "nominal" value of the share: a division by 10 is equivalent to multiplying the number of shares in circulation by 10. On the day of the operation, the share price is mechanically divided by 10: you have 10 times more shares than before but the value of your portfolio has not changed and you have proportionally the same rights (voting and dividend). This operation on a stock is totally independent of the split shares.

 

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© MarketScreener.com 2022
Stocks mentioned in the article
ChangeLast1st jan.
ALPHABET INC. 3.13% 98.64 Delayed Quote.-33.97%
AMAZON.COM, INC. 2.55% 115.88 Delayed Quote.-32.22%
APPLE INC. 3.08% 142.45 Delayed Quote.-22.17%
TESLA, INC. -8.61% 242.4 Delayed Quote.-24.70%