Stocks

Splitting Stocks is Like Splitting Hairs

BrandonWendell
Brandon Wendell
Instructor, CMT

There has been a lot of talk about the recent announcement of Apple splitting their stock. Many traders are unsure what this means for the stock and whether there is any way for them to benefit from the stock split.

Unfortunately, there is not any secret strategy to profit from a stock split. A split is simply a corporate action that reduces the price of their shares while increasing the number of shares outstanding. Shares outstanding is simply the total number of shares that the company has issued. When a company goes public, it creates a certain number of shares that represent ownership in the company. Some of these shares are kept by the insiders of the company, and others are offered to the public. The money raised from selling those shares to the public raises operating capital for the company.

When the company needs to raise more capital, they can issue and sell more shares. This dilutes the ownership of those who already have shares. With more owners, the stockholders’ shares represent a smaller ownership in the company.

Stock splits do not dilute ownership. When the split occurs, the price of the shares are reduced, and more shares are given to current shareholders. There are no new shares created to dilute ownership. This is similar to someone giving your five $20 bills as change for a $100 bill. You still have currency equal to $100, but you have five bills instead of one.

So why does a company want to split their stock price if it does not make any changes on the value or ownership of the stock? Companies want to remain competitive both in their business operations and in the equity markets. When a company’s stock price rises well above the price of their competitors, investors may not be able to afford to buy their stock and will often purchase the competitor’s stock instead.

Buying a competitor’s stock gives the investor participation in the industry at a lower price. If enough people invest in the competitors, their stock will rise. The original high priced company’s stock will become stagnant. So to increase investment activity in the stock, the company will spilt their shares to lower the price.

So the simple answer as to why a split occurs is the psychological advantage. A lower priced stock is more attractive and affordable to investors and traders. Companies want to make their shareholders happy, and increasing share prices does that. You need to create demand in the stock to have the prices increase and a split offer lower prices and the buzz around the stock to do that. Overall, a stock split does nothing to change the mechanics of the stock or the company itself, it just makes you more willing to buy them.

Brandon Wendell
bwendell@tradingacademy.com

Disclaimer
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.