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.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
