What is a Stock Split ?
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Essentially, a stock split is when a company increases the number of shares.
For example, if you own 30 shares of XYZ at $50 per share, and there was a 2-1 ( 2 for 1 ) stock split, you would then own 60 shares worth $25 each. This means that for each share you already own you now get one more. But in order for your shares to have the same market value the price gets split in half too.
So the stock, and thus, your investment, doesn't lose anything!
Let's work it out.
Before the split you had:
30 shares x $50 = $1.500.-
After the split you now have:
60 shares x $25 = $1.500.-
So the total investment on $1.500.- stays the same.
The same would be true if a stock splits 3 for 1. In this case you would get 3 additional stocks for each one you already own.
Why do companies issue stock splits if you still have the same amount of money?
Liquidity!
If you had the choice between two great companies of equal quality, which stock would you buy? The one of company A that costs $500, or the one of company B that goes for $50?
Most probably the $50 stock!
So that's why some companies want to make their stocks inexpensive so more people, especially private investors, can buy/afford them. This creates a condition where more of the company's stock is bought and sold (this is called "increased liquidity").
So generally a stock split is a good thing!
The "problem", in theory, is that the increased activity will also lead to bigger gains and drops in the stock, making it more volatile.
Also, some investors believe splits are good because their thinking goes, "Well, if the stock was at $50, and now it's at $25, it has to go back up to where it was!
This is wrong.
The stock is where it was! Remember that each share now represents half of the equity in the company that it did before the split. That means that each share is entitled to half the dividend, half the earnings, and half of the assets that it once was.
Some companies have been famous for their no-split policies. The Washington Post has traded well into the $600 per share range, and Berkshire Hathaway, (BRKA), which was at $8 a share in the 1960's, has traded around $89,000 (Dec.13, 2005). This has created the welcome condition of a stable shareholder base.
Then again, other companies are famous for their stock splits. From 1967 until 1999 Medtronic (MDT) split their stocks 10 times. Also Microsoft (MSFT), Nokia (NOK) and Cisco Systems (CSCO) have had many stock splits in the past.
If you're interested in which companies are going to split next, just go to:
http://moneycentral.msn.com/investor/calendar/splits/current.asp
Ricky Schmidt
Dec. 13, 2005
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