With new investors trying their hand at investing every day, markets have started moving with news more than ever before; and as of late, stock splits have been the talk of the town. Some of the most common questions I hear are:
- What is a stock split?
- Is it a good thing, or a bad thing?
- Can you make money off a split?
What Is A Split?
Let’s imagine that Stock ABC is currently trading for $100 a share. Assuming that it is a good company with strong fundamentals and innovative leadership, we’ll say that a lot of investors want to buy this stock.
The problem is the price; for those with smaller accounts, $100 per share is too high.
The ABC Company decides to do a 2-to-1 split. Now, instead of being worth $100, each share is now only worth $50 – but for those who already own shares, they receive twice as many.
For those who already own shares, a split does not affect your portfolio. It simply makes it more affordable for those who want to buy, but cannot.
Types Of Splits
Splits can occur on a 2-to-1, 3-to-1, or even 7-to-1 basis. In truth, any combination is possible: it is up to the Board of Directors.
Reverse splits are also possible, in which the price of shares are increased, but they are also merged together. Typically, a reverse split is viewed as a bearish move since many companies do it to avoid getting de-listed from major trading exchanges.
Good News Or Bad News?
This is a good question, and like all good questions, the answer is “it depends”.
A stock split can be a great way for those with less capital to buy into a company they love at a lower price, without affecting the fundamentals of the company.
Many investors see stock splits as a bullish signal, since the Board of Directors is hoping the split will make it more affordable for investors with smaller accounts to be able to get into the market. Also, it could be a way of convincing those who already own shares that the price isn’t over-inflated (this is, of course, a psychology trick since a split does not affect the fundamentals of a company other than increasing liquidity).
Can I Profit From A Split?
Financial theory says, “no”. But there are always people who make an attempt to seize small gains from short term movements in a stock price.
However, these “opportunities” are rarely repeatable and are too inconsistent to create any real chance for profit.
A stock split can be a great way for those with less capital to buy into a company they love at a lower price, without affecting the fundamentals of the company. For those who already own, it won’t affect your portfolio, increase your risk, alter your dividends, or mess with total value.
If the company is sound both quantitatively and qualitatively – and I see a split coming – I like to sit back, relax, and rest assured knowing that my favorite companies are now available to others who see value in what I see value in.
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