Thursday, May 24, 2007

Stock Splits

I’ve got a great deal for 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’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.


Anonymous said...

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?

Middle Class Millionaire said...

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.