Stock Splits - Getting More For Your MoneyFrom time to time, companies will want to change the amount of shares available in their company or the price of their stock. The typical way of doing this involves stock splits and it is very successful in accomplishing the desired objectives. The stock market news has grown very accustomed to this phenomenon and while there is usually some initial excitement over a stock split, the end result is generally very smooth. We will discuss several of the reasons for stock splits and what effect they have on the stock market.
Different types of stock splits can have different effects on Wall Street news based on the reasons they are implemented. Several of the concepts to understand about this technique are literal stock splits, reverse stock splits and dividend payouts.
Literal Stock Splits
Because of the existence of reverse splits, it is necessary to differentiate between the two. For example, a literal stock split occurs when a company announces that it will do a 2-for-1 split of their common stock. If MEW Industries has 1,000 shares of public stock at $50 per share before a 2:1 split, they will have 2,000 shares of public stock at $25 per share after. The stock market average returns for these new shares will reflect the ratio that was used in the split.
There is one primary reason for this stock market strategy, which is to increase liquidity of the stock. Although there are investors buying Google stock at over $500 per share, many more investors would be inclined to buy if there were five times more shares at $100 per share. This tactic is employed by companies if their stock sales stall as the price rises. If the stock doesnít stall companies will typically allow the price to rise, as indicated by Google over $500 per share and Berkshire Hathaway, the marketís all-time stock price leader at over $110,000 per share.
Reverse stock splits are less common and have a somewhat negative investment strategy attached to them. If the price of a stock drops too low, many mutual funds will not purchase them and they even run the risk of being delisted, or removed from the market indexes. In addition, the low stock prices create a psychological stigma as people view them as worthless. By doing a reverse stock split, companies can raise the stock price by lowering the number of outstanding shares, eliminating the problems caused by the low stock prices.
Sometimes a company will choose to avoid a stock split and lower the share prices by paying a stock dividend to shareholders. The effect of this move is somewhat the same as a split in that it lowers the share price since the company is worth less after the payout. This can be a good investment philosophy for companies that already have a large number of available shares plus the move is usually well received by stockholders, since this is basically investing a portion of the profits back into the people that have already invested in the company.
Stock splits have historically been used by companies to increase or lower the number of outstanding shares or to change negative impressions of the stock price. Investment timing in companies like these has shown to be more psychological than factual since stock prices are adjusted and the resulting price movements follow. Stock splits are another interesting feature of investing and a good piece of knowledge for those who are learning about the stock market.