I’ve got a great deal for you…..you give me a one 100 dollar bill and I’ll give you ten 10 dollar bills. Sound like a good deal? Interested? Of course your not interested...it’s not a good deal. Well this is exactly what happens when a stock splits. Essentially, you’re left with the exact same amount of pie…it’s just cut into more pieces.
So if stock splits don’t effect the overall valuation of a company why do they bother to split their stock?
• Make shares seem more affordable to small investors (although the intrinsic value of the company remains the same)
• Could increase the liquidity of the stock as there are more shares available on the market (thus making it easier to trade)
• Could split as a signal to the market that the company's share price has been increasing (the resulting attention could increase demand for the name)
I know many of you that read this blog completely understand what happens when a stock splits, but I just thought that I should go over it for those of you that don’t as I find it really frustrating listening to “water cooler” talk speculating about the potential of stocks to split.
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3 comments:
It seems to me that stocks split in an attempt to keep the share price rising when it has already gone up quite a bit. It supposedly "fools" people into thinking the stock price is cheaper.
BTW, what do you think of reverse-splits?
Personally, I think they are a last ditch desperate attempt by companies trying to keep their share price out of the “penny stock” category. Like stock splits I think many of the benefits of reverse splits are psychological (and even that is questionable as 75% of stocks decrease in value after a reverse split). To me they send a message from the management that the business is in big trouble.
Reverse stock splits can sometimes be used to give the appearance that a company is sound when its really not.
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