Education Resource

Why Do Stocks Split?

Master Instructor Blog

Apple recently announced a 7 for 1 stock split; for each share an investor currently owns they’ll get seven shares. The share price of AAPL immediately increased. Was the stock split the cause of the rise? Or was the rise the cause of the stock split?

In a word, yes. Both answers are right. A stock split makes the shares more attractive to retail investors because of the reduced outlay to own a piece of the company. The total capitalization does not change; $1000 worth of AAPL is still worth $1000.  But it’s now easier to get in without throwing a small portfolio out of balance. And it’s easier to buy even lots of 100 shares, which are more liquid than odd lots.

blog-shutterstock_136126994A stock split is also a sign of financial health at a company. It reminds investors that the price of a company’s shares has increased substantially and tells them that management does not expect the shares to go down again. That’s why the simple announcement of a split can create an immediate bump (usually small) in its price.

There’s also such a thing as a reverse split in which a company reduces the number of outstanding shares in order to make its share price increase. A low price usually is not a good thing since companies rarely go public at single-digit prices, so an under-$10 stock has likely seen a significant decline. The reverse split may even be necessary to keep the stock from being delisted on an exchange.

Not everyone loves stock splits—famously, not Warren Buffett, whose Berkshire Hathaway Class A stock has never split and was recently worth about $190,000 per share. In a 1983 letter to his shareholders, Buffet explained: “Splitting the stock would increase [transfer costs], downgrade the quality of our shareholder population, and encourage a market price less consistently related to intrinsic business value. We see no offsetting advantages.”

At Online Trading Academy, we have a preference for stocks that trade under $50 a share, so AAPL will still be a bit pricey for us. That price allows our students to trade the vast majority of listed tickers and buy reasonably sized positions which can be moved quickly; it’s also easier psychologically for a new investor to trade the smaller share levels because there’s less capital at stake. Yet we have many instructors and students who are avid followers of AAPL—you may be one of them. Its volatility and visibility make it an ideal candidate for our patented supply and demand trading strategy that provides the opportunity for making money on any market move, up or down or even sideways.

By the way, historical records of stock prices are automatically adjusted to reflect stock splits. (Volume records are also adjusted accordingly.) So the investor who says “I wish I’d bought AAPL when it was 30 in 1995” could actually have had several shares for that price because its historical value reflects stock splits up to that time.

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.