Stock Split FAQs
Stock splits may seem like a gift to some investors, but there is little evidence that you benefit in any meaningful way when a company splits its stock.
What is a Stock Split?
If a Company, which is currently priced at $100 per share, announces a 2-for-1 stock split then you own 100 shares before the stock split which is worth $10,000 and you will then own 200 shares worth $10,000 after the stock split.
The market automatically marks down the price of the stock by the divisor of the stock split, so the $100 per share stock price becomes $50 per share. There are other stock splits such as 3-for-1 and 3-for-2, however 2-for-1 is the most common. In terms of what your holdings are worth, nothing changes and in terms of what the company is worth, nothing changes after a stock split.
Why do Stocks Announce Stock Splits?
Perception -- some companies worry when their per share stock price gets too high that it will scare off some investors, especially small investors. Splitting the stock brings the price per share down to a reasonable level.
Liquidity -- if a stocks price rises into the hundreds of dollars per share, it may reduce the trading volume. Increasing the number of outstanding shares at a lower per share price aids liquidity with a stock split.
Is a Stock Split Good for Investors?
Some investors say a stock split is a sign that a stock is doing well and they consider it a buy signal and others caution reading too much into a stock split by itself.
You should always look at the whole picture before making an investment decision. If you want to use stock splits as a marker for stocks to consider for further evaluation, that is a reasonable idea, but dont stop there with your research.
What is a Reverse Stock Split?
You should watch out for one type of split as a possible danger signal and thats the reverse split. In a reverse split, the company reduces the number of outstanding shares and the per share price rises accordingly.
For example, a company might execute a 1-for-2 reverse stock split, which means for every two shares you own, you would now own one and the per share price doubles.
A reverse stock split is often used to prop up a stocks price, since the price rises on the split. Often a company will do a reverse split to keep the stock price from falling below the minimum required by the stock exchange where it is listed.
Clearly, this is a sign that something is wrong if a company cant keep its stock price above the exchanges minimum listing price and caution is advised.
Last Updated: December 21st, 2014