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What is a Stock Split?

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  • Written By: Adam Hill
  • Edited By: Bronwyn Harris
  • Last Modified Date: 05 December 2016
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A stock split is an action by a publicly traded company that has the effect of increasing the number of shares outstanding on the market. For example, in a two-for-one stock split, a company with ten million shares outstanding will split each share in half, so that there will be 20 million shares. When a stock split occurs, the price of a stock is cut proportionally. Again, using the two-for-one example, a stock that is worth $50 U.S. Dollars (USD) before the split will be worth $25 USD per share after.

When a company is planning a stock split, the action must be approved by the company's board of directors, as well as its major shareholders, if it is to occur. Although a company may choose to split its stock when its price is rising, the actual split as such does not affect the market capitalization or value of the company. A company's market capitalization is equal to the number of existing shares, multiplied by the share price. When the number of shares doubles, the price of one share is also cut in half, so there is a net zero effect on total value.

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One common reason to initiate a stock split is to make a firm's stock more accessible to smaller investors, thereby possibly creating greater demand for the stock, and increasing its price. If one share of XYZ stock is valued at $500 USD, an individual investor would have to pay $5,000 USD for 100 shares. This will likely be a significant portion of one investor's portfolio, and may keep him from purchasing the stock, even if he believes that the company is a fundamentally good investment. On the other hand, if one share of XYZ is priced at $25 USD, and the company's fundamentals are the same, the investment will look much more attractive to individuals, whose funds are limited.

A stock split can signal, in some cases, that a company is implicitly confident in its economic future. If this is generally perceived to be the case, this fact alone will increase the market value of the stock. Some companies avoid stock splits as a rule, and have never had one. Berkshire Hathaway, for example, is a publicly traded company whose class A shares have at times sold for well over $100,000 USD. This high share price has reduced the liquidity of the stock, as well as having achieved its intended effect, namely that of attracting long-term investors rather than short-term speculators.

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SkyWhisperer
Post 4

@miriam98 - Warren Buffet is no dummy, so I guess he has his reasons. But if your objective is to get rich you really don’t need to get into expensive stock.

Microsoft went public at something around $30 per share in the mid 1980s. You could have easily gotten rich with a Microsoft stock split, if you bought and held (or purchased additional shares).

That’s because over the course of its history Microsoft has split nine times. That’s more than enough to make anyone rich in my humble opinion.

miriam98
Post 3

@David09 - I would love to own Berkshire Hathaway stock. Unfortunately, I can barely afford a single share of his stock, let alone 100 shares.

Why doesn’t he split his stock so little guys like us can get in? I realize he wants to weed out the rabble, I guess, but the more people who get in the better it is for him. At least that’s my take on it.

David09
Post 2

@everetra - I totally agree with you on the latter point. A stock split doesn’t really change anything. Your total valuation is still the same.

If you had a 100 shares of company X at $10 a share, after a two for 1 split you now own 200 shares of company X at $5 per share. In both cases, your total valuation is $1,000.

It’s the anticipated inflow of new investors at $5 per share that will make you money. Conversely, however, that stock could drop in price, in which case since the company has more shares out there than before, you now have diluted shares.

So there is no guarantee of anything. During the Internet bubble there were a lot of so-called investment gurus peddling stock split secrets, but there is no secret in my opinion. You only profit if the company does well, with or without a split.

everetra
Post 1

Oh, how I love stock splits! I was able to make a lot of money in some technology companies simply as a result of owning shares in the stock and then watching it split. As a result of the split, the shares were half the price they used to be, and this attracted more “value” investors into these good companies.

You will need to do a stock split calculation to determine what your stock is worth on a weighted basis however.

I should point out that a stock split is not a guarantee you will get rich. The company still has to perform and the underlying fundamentals have to be strong, otherwise the stock will hover around the same range, relatively speaking, as it did before the split, and you will be no better for it.

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