Is It Better To Buy a Stock Before or After It Splits?
Posted on Tue, 24th July, 2007 by Jeremy
You’ve probably heard of stocks splitting before and maybe you even have a friend who brags about one of their stocks that just split so you’re thinking of getting in on the action. So, is it better to buy a stock before it splits or after? Well, that is like asking, “Should I buy a 12″ pizza cut into 4 pieces or 8 pieces?” It is the same amount of pizza for the same price, just a different number of pieces.
An Example of a Stock Split
The most common type of split is one in which you receive more shares of the underlying company. For example, ABC Corp. is trading at $50 per share and you own 100 shares, or a total of $5,000. If ABC Corp. decides to issue a 2-for-1 split this means you will receive two shares of stock for every one that you own. Sounds great right, you are doubling your shares! After the split your account will show 200 shares of stock and an account value of still $5,000 because each share is now $25. When a stock splits the number of shares change but the overall value of the company remains the same, so the share price is adjusted to reflect that.
There is also another type of split called a reverse split. In this case the opposite is true. Instead of getting more shares you actually receive less. So a 1-for-2 reverse split would mean that for every two shares you own you will then only have one. Again, the share price would double since your total shares were cut in half so the actual value of your investment remains unchanged.
Why Do Companies Split Stock?
The primary reason for a company to split their stock is to keep the share price affordable for investors. If you take a company that has been around for decades and has experienced a lot of long-term growth you would find that their share price of $50 in 1950 could have grown to tens of thousands of dollars per share today. Again, when a stock splits it is merely an adjustment in the total number of outstanding shares which changes the price per share. The company is not worth more or worth less simply because of a split.
When you are talking about a reverse split there may be other factors in play. Typically a company will issue a reverse split when their stock price has gotten too low, so the reverse split will increase the price per share. Unfortunately if a stock is doing very poorly and begins to drop enough to warrant a reverse split this could be a red flag that signals the company is not a good investment. A reverse split alone isn’t enough to make that decision, but it should be a cause for further research.
So Why All The Hype Around Splitting Stocks?
During the 90’s there were a lot of people who got real excited about stock splits because they may have purchased 100 shares of some company that later split, grew and split again, and grew and split again, etc. So 100 shares may have turned into a few thousand shares in a few years. On the surface this is very exciting and it is likely that you would have made a lot of money on that company, but really it doesn’t matter much. What is the difference between 100 shares valued at $1.00 each or 1 share valued at $100? Nothing.
When Should You Buy?
In the end it really won’t matter if you are investing for the long-term. I could buy 100 shares of a company trading at $50 today or I could buy 200 shares of the same company at $25 tomorrow after a split and the outcome is identical. The only thing that may change from the day before the split to the day after the split is the actual price due to trading fluctuations. Again, as long as you are buying the stock to hold for a while the few cents per share it changes will have very little to do with your overall outcome.
So the only person who gains from share splitting is the stock brocker who you pay based on the number of shares you purchase.
Well that is a possibility, but considering most discount brokers don’t charge based on the number of shares bought or sold and instead use a flat rate that probably wouldn’t apply to most investors.
But you bring up a good point, if you do use a broker that charges based on the number of shares sold then yes, that could be an important thing to consider.
Thanks for bringing that up!
a quick note — it really depends on the individual stock. some stock splits don’t matter, don’t affect the price much. some do.
as a real-world example, i have a ~$0.40 dividend paying stock that splits in some form every 5 or so years, in the $40 range. once it splits, people tend to gobble it back up because a $0.40 dividend on a $20 stock is a somewhat attractive proposition. so the stock will tend to jump a bit immediately after the split, making the purchase beforehand worthwhile.
That’s true, mitchell. That is why I specified for people getting into a stock for the long-term don’t have anything to really worry about.
But you are right, there is always a little bit of a frenzy when a split is announced and some people try to profit on the short-term bump and speculation.
Mitchell,
That’s only true if the dividend doesn’t split too. Most of the time everything associated with the stock adjusts for the split unless the company “raises” its dividend.
Check out the price of Berkshire Hathaway (BRK). A famous stock in a legendary company that has never split. I don’t think a split has much value. After all, the shares are owned by someone anyway so a split really produces no value for the company itself, hence neither for the shareholders except debatably liquidity due to affordability. About the only sure thing it does produce is fees to the bankers that have to execute the split.
Splits help the investor to diversify when the investor have a limited amount of capital. A stock that trades for 10$ is easier to adjust the amount invested then a stock like BRK that trades for 3.600$(B) and 111.000$ (A).$
So if 111.000$ or multiples there of is considered a small part of your portfolio then splits don’t matter in the long run.
But conny: How does that help the company?