Posted: 1/17/2013 8:26:46 PM EDT
| I read and tried to understand several articles on the internet about how stock splits work. I still don't understand, though. One article said that if a stock splits, then I now have twice as many shares, but they are worth half as much as what they were. That doesn't make sense to me, though. I've looked at stock charts, and the prices have gone right back up. So, how could each share be worth half as much? Or, when a stock splits, and stays at the same price, do I now have twice as much money? |
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As you describe is exactly how a 2:1 stock split works: you have twice as many shares at 1/2 the price; value remain the same.
There are other stock split ratios, but 2:1 is common. There are also reverse stock splits where the opposite occurs: they halve your shares and double (in a 1:2) the price. |
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Companies have a variety of reasons for doing splits. Psychologically, some people are less likely to buy a stock if the price is too "high" or "low". This is silly, because the value is derived by the total value of the company (market cap) divided by the number of outstanding shares. So, I could have a company worth $100,000 and issues 10 shares. Each share is worth $10,000, which feels "expensive". Alternatively, I could issue 5,000 shares, making each share worth $20. This feels like a good deal, even though the total number of shares in each case is worth $100K. Citibank did a reverse split a few years ago. It was a 10:1 split. After the bloodbath of 2008, Citi was trading for around $1, and only slowly going up. When it reached $3.50 or so, the company decided to do a reverse split. Basically, they made 10 of the old shares (at 3.50) worth 1 new share, worth $35. There was absolutely no change in value here. You owned 1/10th the number of shares, but they were worth 10 times as much. Now, Citi doesn't "look" like a cheap or poor stock. They're priced at $35 which is a nice, middle of the road number. If you look at the market, the great majority of stocks are priced in the $10-50 range. Some stocks are famous for never splitting. Buffet's Berkshire Hathaway A-class shares have never split. They're now worth $143,000. As I recall, Google and Apple have never split. They're worth around $720 and $500, respectively. To the novice investor, they seem expensive. The value of a stock has nothing to do with the current stock price itself. You need to consider price/earnings ratio, price/book value, and a number of other things. Keep reading. |
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Quoted:
Thank you for explaining. I still don't understand, though, how my shares would be worth half as much after a split. A company can't go into my stock brokerage account and change the value of my portfolio. How does the stock become worth half as much? Basically because they said so. They don't go into your account, they do it via whatever exchange the stock is traded on. They decide to do it on a given date, at the close, stock price is halved (again in a 2:1) and your shares are doubled. You now have twice as many shares at half the price = same as you had before the split. When you say "they continue to go up" well, the next day (after the split) they trade as they normally would, up or down. |
| Think of it like a pie or pizza. All they are doing is changing the sizes of the slices there is still the same amount of pie there. If you have 50 shares of abc worth ten bucks each and they do a 2:1 split you will have 25 shares worth 20 each. Either way your shares are worth $500 and your ownership percentage of the company is unchanged. |
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For what it's worth, it's important to understand that splits don't really add (or take away) value from a stock. There's no real benefit to a split in either direction for all practical purposes. The company is worth the same as it was before, just with more (or less) shares representing that same value and your proportion of ownership remaining the exact same.
The "newbie" fallacy is to think that a split makes the shares "cheaper". This is most certainly not the case. Share price is irrelevant, the only thing that matters is earnings per share and what you have to pay for those earnings per share hence the ratio P/E or Price to Earnings. Earnings or the growth thereof are what investors pay for and what tells you if a stock is expensive or not. If the P/E was 15 before the split then the P/E will be 15 after the split thus the stock is no more or less expensive than it was before even if the share price has changed. I don't know if I'm doing a good job explaining that but do your best to understand it because it's an important point. |
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Quoted:
Quoted:
Thank you for explaining. I still don't understand, though, how my shares would be worth half as much after a split. A company can't go into my stock brokerage account and change the value of my portfolio. How does the stock become worth half as much? Basically because they said so. They don't go into your account, they do it via whatever exchange the stock is traded on. They decide to do it on a given date, at the close, stock price is halved (again in a 2:1) and your shares are doubled. You now have twice as many shares at half the price = same as you had before the split. When you say "they continue to go up" well, the next day (after the split) they trade as they normally would, up or down. It's worth noting that nobody actually physically halves the price of the stock. It's actually just the result of the first trade after the effective date of the split that sets the new "post-split" price. It always works out to near the exact same ratio as the split itself because no sane trader would pay the pre-split price after the split when there are twice as many shares now outstanding. But it's not like your broker, or the exchange, or the company whose stock you own, actually goes in and manually sets the value in half. It's all done by invisible hand of the market itself. I know you know that, I'm just explaining it for the OP. |