Good question. Many investors own stocks that split and don't really understand what this means. So, on their behalf as well, I thank you for asking.
A stock split won't change your stake in a company, but it may (note I write "may") boost the stock's price.
WHAT IS A SPLIT?
A stock split is like receiving two $10 bills for a $20. It's really that simple. The company simply increases its number of outstanding shares. There is no change in your equity. In other words, you now have two pieces of paper but your $20 is still only worth $20.
Splits come in many shapes and sizes. They can be 2-for-1, 3-for-1, even a reverse split, such as 1:4.
THE IMPACT OF A SPLIT
Keep these 5 points in mind, when you hear about an impending stock split:
1) INCREASED INVESTOR INTEREST
While the value of the money in your pocket has not changed, stock splits are a positive in that they stimulate investor interest. This, of course, is one of the reasons why management declares a split -- to increase the visibility of its shares in hopes that more people will buy the stock. With increased volume, on the buy side, the share price is likely to rise, although there's no guarantee that it will.
2) A HIGHER DIVIDEND
A split may also mean that the company will increase its cash dividend. A study done by the New York Stock Exchange a few years ago found that about 58% of the companies surveyed said they increased their cash dividends at or around the time of their stock split.
3) A LOWER PRICE
Splits almost always bring a stock down into a more popular trading range because the split decreases the price per share. Management realizes that an extremely high price does not go over well with many small individual investors and that psychologically, these investors are apt to shy away from buying 100 shares of an $80 stock but are less hesitant to buy 200 shares at $40/share.
4) BUY BEFORE OR AFTER A SPLIT?
This is a very common question and over the years there have been a number of studies on the topic with the results supporting both sides of the issue. These two survey findings, however, appear to be sound:
In 97% of the cases studied, the stock increased on average 5.2% the day the split was announced.
For six months after the split, 75% of the stocks split outperformed the Dow. But in all fairness, this study did not address the issue of whether the stock split caused the rise in price or something else did, such as increased earnings.
So, it appears that the best time to own a splitting stock is prior to or immediately after the announcement.
5) INCREASED FUTURE EARNINGS
One conclusion we can draw fairly conclusively is that when management decides to split its stock it's because the stock has moved up in price over time and the company feels pretty confident that future earnings growth will continue.
WHAT TO DO
If a stock you own declares a split and your shares are held here at BUYandHOLD, the additional shares will show up on your account statement.
CAUTION: The mirror image of the stock split is the reverse split, generally a negative event. You'll find all the pros and cons of reverse splits discussed in one of my previous columns.
FOR MORE INFORMATION
I urge you to log on to: http://www.stocksplits.net/. Here you'll find these specific details about both recent and forthcoming splits:
The symbol
Type of split (2:1 or 3:4, etc.)
Announcement date
The ex-dividend date
The number of prior splits
Price the month prior to the announcement date
Price at the announcement date
The pay date price
(Pay date is the last day before the split is reflected. Ex-dividend or ex-date is the first day the stock trades reflecting the split.)
The experts at StockSplits.net also spell out an investment program based on stock splits. I'm neither recommending nor not recommending it, but it is interesting. They also note that based on their statistics, "as stocks approach their split day, investors get really interested. The price rises into the split and drops shortly after the split."