Learn The Stock Market And How to Trade

What’s worth more to you a peanut butter and jelly sandwich or a peanut butter and jelly sandwich cut in half?  From a pure financial theory standpoint a stock split has absolutely zero impact on the worth of the stock.  If you stock is worth $10 per share and splits into 2 shares worth $5 each absolutely nothing has changed with the company it is just paper pushing.

So why do companies choose to split a stock?  Mainly for psychological reasons such as bringing the face value of the stock down to a “more reasonable level” because certain big round numbers may scare off smaller investors.  The other, and probably more valid reason, is to create more liquidity in their market.   If there is 10 million shares in the float and a company does a 3:1 split there would then be 30 million shares in the float.  Now traders can trade a smaller percentage of the company at any given trade increasing the liquidity and potentially lowering the spread.  These both can be good things for traders and investors, however this doesn’t mean you should invest in a company just because they are having a stock split.  If either the fundamentals or technical indicators are driving the price of a stock down a stock split will do absolutely nothing to change these factors.

One final point to be aware of is the possibility of the reverse split.  In the reverse split a company will increase the value of each share by reducing the number of shares.  A common reverse split will give you 1 share for every 10 shares you own.  A common reason for this is to keep a company out of the penny stock territory.

In general I feel companies that concern themselves with stock splits are spending too much time worrying about the short term market fluctuations and not enough effort actually creating value for their customers to produce profits for their shareholders.  But hey, call me old fashioned.

Related posts:

1. Stock Market 101
2. Common Stock Vs Preferred Stock
3. B Stock
4. Float – Authorized – Outstanding Shares – Oh My!
5. Issued Shares – The Hidden Dividend or Stealing Money