Fractional Shares: Understanding and Benefits

A fractional share is when a full single share is split. For example, fractional shares occur during stock splits, dividend reinvestment plansDividend Reinvestment Plan (DRIP)A dividend reinvestment plan (DRIP or DRP) is a plan offered by a company to shareholders that it allows them to automatically reinvest their, 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.

Summary

• 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 brokeragesBrokerageA brokerage provides intermediary services in various areas, e.g., investing, obtaining a loan, or purchasing real estate. A broker is an intermediary who 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.

4. Others

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 diversificationDiversificationDiversification is a technique of allocating portfolio resources or capital to a variety of investments.The goal of diversification is to mitigate losses 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:

• Interactive Brokers
• Fidelity
• M1 Finance
• Public
• Robinhood
• Schwab
• Betterment
• Stash

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.

Related Readings

CFI offers the Capital Markets & Securities Analyst (CMSA)™Program Page - CMSAEnroll in CFI's CMSA® program and become a certified Capital Markets &Securities Analyst. Advance your career with our certification programs and courses. certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:

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