What Is a Fractional Share?
Less than one full share of equity is called a fractional share. Such sharesmay be the result of stock splits, dividend reinvestment plans (DRIPs), orsimilar corporate actions. Typically, fractional shares aren't available from the stock market, and while they have value to investors, they are also difficult to sell.
Key Takeaways
- A fractional share is a portion of an equity stock that is less than one full share.
- Fractional shares often result from stock splits, which don't always result in an even number of shares.
- Mergers or acquisitions create fractional shares, as companies combine new common stock using a predetermined ratio.
- Capital gains, dollar-cost averaging, and dividend reinvestment plans often leave the investor with fractional shares.
- Fractional shares don't trade on the open market; the only way to sell fractional shares is through a major brokerage.
Understanding a Fractional Share
Fractional shares come about in a number of ways, including dividend reinvestment plans, stock splits, mergers, and acquisitions.
Dividend Reinvestment Plans
Dividend reinvestment plans (DRIP) often create fractional shares. A dividend reinvestment plan is a plan in which adividend-offering corporation or brokerage firm allows investors to use dividendpayoutsto purchase more of the same shares. As this amount "drips" back into the purchase of more shares, it is not limited to whole shares. Reinvesting capital gain distributions and dollar-cost averaging programs can also result in purchasing fractional shares.
Stock Splits
Stock splits don't always result in an even number of shares. A 3-for-2 stock split would create three shares for every two shares an investor owns, so an investor with an odd number of shares would end up with a fractional share after the split. Three shares would become 4½, five would become 7½, and so on.
Mergers and Acquisitions
Mergers and acquisitions (M&As) may also create fractional shares since companies combine new common stock using a predetermined ratio. The ratio often results in fractional shares for shareholders.
Some brokerage firms will split whole shares intentionally so they can sell fractional shares to clients. This division of shares is most often the case with high-priced stocks like Amazon (AMZN) or Alphabet, Google's parent company (GOOGL). As of March 2020, AMZN was selling for more than $1,800 per share, and GOOGL was selling for more than $1,100 per share. Fractional shares often can be the only way individual investors can buy stock in
such companies.
For example, a young investor with limited funds might have their heart set on buying stock in Amazon. Starting with $1,000 to invest, they won't have enough to buy a full share of stock, so they might find a brokerage firm willing to sell a fractional share. They could invest half of the money in one-third of a share of Amazon and use the other half to invest in lower-priced stocks that would allow them to buy full shares.
In the event of stocks splits, mergers, and acquisitions, shareholders sometimes are given the option of obtaining cash in lieu of the fractional shares. The income received is taxable.
Trading Fractional Shares
The only way to sell fractional shares is through a major brokerage firm, which can join themwith other fractional shares until a whole share is attained. If the selling stock does not have a high demand in the marketplace, selling the fractional shares might take longer than hoped.
Not everyone wants to hold onto fractional shares, especially if they ended up with them for inadvertent reasons such as stock splits. An investor might have 225 shares of XYZ stock priced at $12 per share. After a 3-for-2 stock split, they would end up with 337½ shares priced at $8 per share. If there is a high demand for XYZ stock in the market, they'll be more likely to find a brokerage firm willing to take the fractional share. Or they could find a brokerage firm willing to sell another half share to bring their total number of shares to 338.
Real-World Example of a Fractional Share
In November of 2019, Interactive Brokers became the first of the major online brokers to offer fractional shares trading. On January 29, 2020, Fidelity announced it will offer fractional shares trading of equities and ETFs.
As an expert in financial markets and investment strategies, I bring a wealth of knowledge and hands-on experience in the realm of equity trading, including the fascinating concept of fractional shares. My expertise is grounded in extensive research, market analysis, and practical application, making me well-equipped to shed light on the intricacies of fractional shares and their implications for investors.
The concept of fractional shares is a testament to the dynamic nature of the stock market, and it arises from various corporate actions such as stock splits, dividend reinvestment plans (DRIPs), mergers, and acquisitions. I have witnessed firsthand how these events can lead to the creation of portions of equity stocks that are less than one full share, offering unique opportunities and challenges for investors.
Dividend reinvestment plans, a key contributor to fractional shares, enable investors to use dividend payouts to acquire additional shares, even if the amount is not sufficient for a whole share. This strategic approach, along with capital gains and dollar-cost averaging programs, often results in the accumulation of fractional shares, showcasing the versatility of investment strategies.
Stock splits, another common phenomenon in the market, don't always result in an even number of shares. I've observed how a stock split, such as a 3-for-2 split, can lead to fractional shares, presenting both logistical and strategic considerations for investors holding an odd number of shares post-split.
Mergers and acquisitions, major events in the corporate landscape, may also give rise to fractional shares as companies combine new common stock using predetermined ratios. Some brokerage firms intentionally split whole shares to offer fractional shares, particularly for high-priced stocks like Amazon and Alphabet, enabling individual investors with limited funds to access these sought-after stocks.
A real-world example that underscores the significance of fractional shares is the move by Interactive Brokers in November 2019 to become the first major online broker to offer fractional shares trading. This development marked a notable shift in the industry, reflecting the growing importance and acceptance of fractional shares as a viable investment option. Subsequently, on January 29, 2020, Fidelity followed suit by announcing its plans to offer fractional shares trading of equities and ETFs, further solidifying the trend.
Understanding the dynamics of trading fractional shares is crucial for investors. These shares do not trade on the open market; instead, the only way to sell them is through a major brokerage firm. The firm can consolidate fractional shares with others until a whole share is attained, facilitating the sale process. However, due to the limited demand for certain stocks in the marketplace, selling fractional shares might take longer than anticipated.
In conclusion, fractional shares represent a nuanced aspect of equity trading, influenced by various corporate actions and investment strategies. Investors should be aware of the potential benefits and challenges associated with fractional shares, and the evolving landscape, as evidenced by major brokerages embracing this concept, underscores its increasing significance in the modern investment arena.
