What is Fractional Shares?
A Fractional share is less than one full share of the equity. Such shares may be the result of stock splits, dividend reinvestment plans (DRIPs), or similar corporate actions which don’t always result in an even number of shares. These shares have value to investors but such shares are not available from the stock market and they are difficult to sell.
They are created by mergers or acquisitions as companies combine new common stock using a predetermined ratio. Capital gains, dollar-cost averaging, and dividend reinvestment plans often leave the investors with fractional shares. Such shares are not traded in the open market. A major brokerage is the only way to sell them.
Understanding Fractional Shares
Numerous ways they can be found include dividend reinvestment plans, stock splits, mergers, and acquisitions.
- Dividend Reinvestment Plans: Here the shares are often created by Dividend Reinvestment plans. Under this plan, a dividend-offering corporation or brokerage firm allows investors to use dividend payouts to purchase more of the same shares. This is not limited to whole shares as this amount drips back into the purchase of more shares. Purchasing of these shares also results from reinvesting capital gain distributions and dollar-cost averaging programs.
- Stock Splits: these 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: Since companies combine new common stock using a predetermined ratio, Mergers and Acquisitions (M&As) may also create these kinds of shares. This ratio often results in fractional shares for shareholders.
In order to sell them to clients, some brokerage firms split the whole shares intentionally. Such division generally happens with high-priced stocks like Amazon or Alphabet, Google’s parent company (GOOGL). These shares are often the only way individual investors can buy stock in such companies. For example; if a young investor with limited funds wants to buy shares, but they don’t have sufficient funds to purchase a full share of stock. In such a case, buying a fractional share from the brokerage firm is what they look for. The money could be used in such a way, so as to invest half of it in one-third of a share of Amazon, and use the other half to invest in lower-priced stocks which would allow them to buy full shares.
Trading Fractional Shares
Trading through major brokerage firms is the only way to sell fractional shares. These firms can join them with other fractional shares until a whole share is attained. The selling of these shares might take longer where the selling stock does not have a high demand in the marketplace. These aren’t exactly shares everyone wants to keep a hold of. Most people end up with them due to inadvertent reasons such as stock splits. Where an investor has XYZ stock which has a high demand in the market, they’ll be more likely to find a brokerage firm willing to take the fractional share.
Fractional Shares’ Example:
Interactive Brokers became the first of the major online brokers to offer fractional shares trading in 2019, whereas Fidelity announced in 2020 that it will offer fractional shares trading of equities.
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Along with this document, make sure you see these other templates in our library:
- Shareholder Pre-Emptive Rights
- Important Legal Considerations When Issuing and Transferring Shares
- Nominal Value of Shares
- Do I need a share vesting agreement?
- Share Options vs Share Vesting
