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How does a stock-split influence underlying value?

Since I own more shares, but each is worth less, why would I be happy about a split? Is this done solely to make the price look cheaper to others?

Feb 14, 2012 by Dane from Rollingbay, WA in  |  Flag
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The choice a company makes to split its stock is as much of a marketing decision as it is anything else, and how investors view splits at the time plays a large part. Here’s a little history lesson… back in the early 1900s, investors in general had the view that a high stock price meant that the company was of high quality. That’s why the Dow Jones Industrial Average, which dates back to that period, was created as a “price weighted” index. Higher priced stocks—and therefore, stocks perceived as higher quality—were rewarded with a higher weighting in the index. That’s the way investors viewed things, and companies accommodated them by splitting their stock less often, and by allowing them to benefit by the quality-bias afforded to higher priced stocks.

Fast forward from that point to the 1990s, and stock splits were viewed by investors as a sign of faster company growth. In many ways, it was the signal to the marketplace that the stock had doubled or tripled again, and it was time to split the stock so it could surge ahead. Investors wanted bragging rights about how quickly their stocks had grown, and how frequently their stocks had split, and companies obliged by splitting their stock at every opportunity. It also didn’t hurt that lower stock prices are less of a mental obstacle for investors. Many investors will stay away from a $500 stock because they view it as “expensive”, even though it may still be a great “value” at that price.

It’s interesting to note that even today we see more of the old-school market mentality cropping up. Investors revere companies with higher stock prices, even though they may still be reluctant to buy at the higher price, which to some degree is why there are again fewer stock splits. In the end, it really boils down to how the company best feels they can make their shareholders, and the investing community at large, happier. If lower stock prices, the perception of growth, and more liquidity gets the job done, a company will split their stock… if a higher stock price, and a higher perceived value are desired by investors, then that’s what they’ll get.

Comment   |  Flag   |  Feb 14, 2012 from Cumming, GA

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It is a marketing gimmick! Well, not really, but in a way you could call it that. If a stock is trading at $100 a share, and a standard lot size is in the 100 share category, that means any individual investor would need to commit $10,000 at minimum to be a stockholder of the company. If a split occurs, reducing the stock price to $50 per share, it will open the doors to some investors that would only want to commit $5,000 of their investment dollars to the position (in the name of diversification, or just because of uncertainty in the investment), yet the person wanting to invest $10,000 simply now buys 200 shares. Since the market value of a stock is truly a supply & demand issue, the thought is a lower stock price will increase the demand to a slight extent, therefore causing an escalation to the company’s market value. In many circles, the increase to the company’s market value is considered a temporary bubble, as in the end the market always says “If I invest in you, what can you do for me?” meaning they are looking for earnings and/or growth per $ invested. Stock splits have no influence on either company earnings or growth of the company, so the split only creates a up bubble on the demand side. The real question is the longevity of the impact on demand, and whether that dictates investors willingness to accept a higher Price/Earnings ratio.

Comment   |  Flag   |  Feb 14, 2012 from East Dundee, IL

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You are spot on. A stock split does not increase or decrease the value of a stock. For some reason people just love stock splits

Comment   |  Flag   |  Feb 14, 2012 from Cleveland, OH

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