A fractional share is when a full single share is split. For example, fractional shares occur during stock splits, dividend reinvestment plans, or various other actions that may result in a partial share of ownership.
Generally speaking, the stock market does not offer partial shares, and while some do, it can indeed be difficult to sell; thus, making the stock more illiquid.
A fractional share represents a portion of a full share.
Fractional shares occur due to several reasons, including stock splits, and dividend reinvestment plans, stock splits, and M&A activity.
The shares are not usually traded on the stock market and are often exchanged by large brokerage firms.
How a Fractional Share is Formed
There are numerous ways a fractional share is made, including:
1. Dividend Reinvestment Plans
Dividend reinvestment plans are plans offered by corporations or brokerages to allow investors to use the dividends they receive from the company to purchase more shares. There may be instances when the dividend amount to reinvest is insufficient and cannot purchase whole shares but rather only a partial amount.
Therefore, dividend reinvestment plans are created so that there are no limitations to purchasing whole shares. In general, reinvesting capital gain distributions can also result in the purchase of fractional shares.
2. Stock Splits
When a company undergoes a stock split, it may not necessarily result in an even number, such as a 4 for 2 or 6 for 2. Often, there would be instances where a 5 for 2 stock split would occur, where every 2 stocks would result in 5 stocks post-transaction.
Investors who hold stocks that undergo stock splits and own an odd number of shares would likely end up with a fractional share. For example, if Apple undergoes a 5 for 2 stock split and an investor owns 3 stocks, they would receive 7.5 stocks after the stock split.
3. M&A Activity
Merger and acquisition activity creates fractional shares, as companies combine their new common stock based on a predetermined ratio. The ratio can result in the distribution of fractional shares to current shareholders of the target company.
In some cases, brokerage firms will intentionally sell fractional shares to clients when the share costs too much. For example, high-priced stocks – such as Amazon or Apple – are companies that many individual investors carry within their portfolio. They are growing companies that continue to take the stock market by storm and yield high growth potential.
However, before their stock splits, both stocks were trading above $1,000 per share. As many investors lack the capital to purchase a large number of the shares, some decide to buy fractional shares of the companies instead.
They can buy fractional shares from brokerage firms that are willing to sell it to them. For example, Johnny keeps a $1,000 portfolio, all in cash. He wishes to buy an Apple stock, which is $1,000. He can find a brokerage firm that is willing to sell him half of an Apple stock for $500, while his remaining $500 can be spent on a variety of other cheaper stocks for diversification purposes.
How to Trade Fractional Shares
As fractional shares are uncommon, the only way to trade them is through a large brokerage firm. The large brokerage firms will buy partial shares from other investors to make them whole again. If the whole stock is not traded frequently, selling a partial stock will be even more difficult.
Companies that Buy Fractional Shares
Several companies offer to buy and sell fractional shares. Some of these include:
In November 2019, Interactive Brokers, a major online brokerage firm, first announced the opportunity to offer fractional shares trading. Later, in January 2020, Fidelity announced that it would offer fractional shares trading for stocks and ETFs.
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