Stock Splits

Stock Splits: This is where most people get pretty confused about the market because of fractions and other math related complications. I always found when I was in school that there was a mutual hatred for fractions amongst students. Now stock splits can seem like a blessing but there’s little evidence that supports it helps anyone at all. Here’s an explanation of a classic stock split scenario.

Let’s say for example a company is currently priced at $100 a share and that you own 100 shares of said company. So, the owner of this company now announces that there will be a 2 for 1 stock split effective immediately. Right now, you have 100 shares valued at $100 a share leaving you with $10000 worth of shares total. However, after the stock split you will have 200 shares worth $50 a share but still coming to the same grand total of $10000. The price of the stock is knocked down by the divisor of the split. 2 for 1 is the most common type of split however, there are also 3 for 1 splits, 3 for 2 splits, 1 for 2 reverse splits and so on.  

Why Companies Choose to Split:

There are two major reasons for a company to decide to split their stock. The first of those reasons are good old perception. A lot of companies worry that high share prices will scare off investors especially smaller investors. Splitting the stock makes shares more affordable for people who don’t have a high level of financial freedom.  

The second reason for a company to split a stock is to increase the liquidity of their stock. When a stock’s price raises into the hundreds of dollars mark, it may reduce the trading volume. Increasing the number of outstanding shares while lowering the price of said shares aids liquidity heavily. You might be wondering now ok are stock splits good or bad for investors?

How this Effects Investors: Some people tend to say that a stock split is good news and that it means it’s time to buy this stock that it’s doing well. Personally, I don’t recommend reading too much into a stock split. Using splits as a marker for stock performance is a decent idea, but don’t cut your research short. ALWAYS look at the whole picture before investing this is real money you can lose this is a game filled with grave financial consequences if played incorrectly. However, there is one kind of stock split that may have potential danger involved with it. This warning signal is called a reverse split and can be frightening. 

In a reverse split, the company reduces the number of outstanding shares and the price of said shares increases. If a company has a 1 for 2 reverse split that means you lose half your shares, but they double in price. Most of the time this is done to keep the company from falling below the minimum listing price set by the exchange it’s under. If a company can’t keep the price of their stock above the minimum listing price it is obviously a sign that something is terribly wrong. 

In conclusion if you are paying your stock broker based on the number of shares you purchase it’s smart to buy them before a split. However, most brokers these days tend to charge a flat rate fee instead of by number of stocks you purchase. If you’re still being charged by the number of stock purchased there are a number of great split calendars online to view when and what stocks will be splitting soon.