You read about them all the time. XYZ is doing a good business and there is going to be a stock split. Should you be concerned about this if you own the stock or should you be rubbing your hands together in glee at the thought of having more shares? If you read about a company having a split, is that the time to grab up shares before they complete the process?
The answer is that a stock split is a tool used by companies to make the share price more attractive to a bigger variety of investors. If XYZ shares are trading at $90 per share, and the company decides to have a split, it merely means that the new shares are worth $45 if they have a two way split or $30 if they have a three way split. If you start out with 100 shares worth $90 ($9,000 total worth) you will end up with 200 shares at $45 or 300 shares at $30. All of them are still worth the $9,000.
So what is the advantage? Some investors don’t like the thought of a stock price being as high as $90. It really is just a mental game. Do you like the sound of owning 1000 shares of IBM? Or would it sound better to you owning 10,000 shares? If the value is the same, it really makes no difference. Some people will point to dividends and gains and say that they are based on a per share basis, so having more shares is to your advantage.
Let’s take a look at that. The price of a share of stock is based on the worth of the company. Now, there are other things that enter the picture of why a share is priced as it is, but let’s just stock to fundamentals for the sake of this discussion. In an oversimplification here is an example of what this is all about.
XYZ is worth ten million dollars. They can issue ten million shares at one dollar per share or they can issue ten shares at one million dollars each. If the shares rise ten percent in value the one dollar shares will now be worth $1.10. The million dollar shares will now be worth $1.1 million. The basic valuation of the company would be at $11 million in either scenario.
The same holds true with a dividend. If the company is sending out a dividend of 10% the numbers are still holding true. There is one million in total distribution, and it doesn’t really matter how many ways you are dividing it up. It is still the same amount of money being divvied up. If you are holding 100 shares at one dollar each, your part of the 10% will be ten dollars. If there is a stock split, 2 for 1, you will have 200 shares worth fifty cents each and your stock value will still be one hundred dollars and your 10% will still be ten dollars.
So why do companies do stock splits? Like I said earlier, it is a mental exercise. When you are entering parameters into a stock screener, you might enter share price between 10 and 20 dollars, so any higher priced stocks will never come up for you. If you like buying even numbers of stocks – blocks of 100 or 1000 or whatever – you might not ever look at stocks with a price of $100. Companies know there are mental blocks for people, and splits are one way to get around that block.
Do all companies do this? No. Berkshire Hathaway, Warren Buffett’s vehicle is now priced at over $132,000 per share. Even his ‘cheap’ stock, Berkshire “B” shares are over $4,000 per share. It’s all just a philosophy. In the long run splits don’t earn more money for you, they are just a way of making a price adjustment.