A stock split occurs when a corporation decides to issue new stock and distribute it to it's current stockholders. This is a decision made by the company's board of directors.
The most common stock split is a 2 for 1 split. When this happens the stockholder will now own twice as many shares as before the split but at half the price. The total value of your stock does not change. For instance, if you owned 100 shares before the split and the price was $50 a share, after the split you would own 200 shares at $25 a share. After the split the shareholder owns exactly the same percentage of the company as before the split, only the number or shares and share price has changed.
While a 2 for 1 split is the most common, companies also distribute 3 for 1 splits, 3 for 2 splits, 5 for 1 splits, etc.
Why does a Company Split their Stock?
Companies will split their stock when they feel that the share price has grown to the point that it will no longer be considered affordable by many investors. Since most stock transactions are in round lots (lots of 100 shares), the total cost for 100 shares might be out of reach for some investors. Once a stock price hits $100 a share, for instance, evidence shows that many investors consider it to be too expensive. If the price per share were reduced it would be more affordable. The effect of more people buying the shares will hopefully lead to a price gain.
What effect does a Stock Split have on the Share Price?
When a company splits it stock it sends the message that the company has been profitable and it will probably continue to prosper. Companies normally announce their upcoming stock split some time in advance. Many investors and traders search for these companies and consider them prime candidates for a further price increase.
In theory a stock split should have no impact on the value of the stock, it should be a neutral event. The only thing that has changed is the share price and number of shares. When you do the math you still have the same value and the same percentage of ownership in the company. In practice however, companies who split their stock most often see price increase when the split is announced or after the split actually occurs. The company knows this and is eager to see it's stock price increase.
Sometimes a company will issue a reverse split. When this happens the shareholder will have less shares at a greater price. For example, a typical reverse split is a 1 for 10 split. For example, if a company has been trading at $1 a share and you have 100 shares, after a 1 for 10 split you will have 10 shares at $10 a share. A company might perform a reverse split when their share price has dropped to a very low level and they want to increase the share price to appear more respectable to potential investors. In addition, some exchanges will de-list a stock when the price drops below a certain level for 30 days.
Harry Hooper has over 30 years experience in portfolio management. He is the senior stock tracker for http://www.stock4today.com.
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