A stock split is a common term for a stock dividend. When a company pays a stock dividend, it issues a certain number of new shares to existing stockholders based on their current holdings. For example: In a 100 percent stock dividend, an investor who owns 100 shares of stock receives an additional 100 shares. The split will not change the value of his holding: the total number of shares doubles but the stock price drops by 50 percent -- is split in half. A 100 percent stock dividend constitutes a 2-for-1 stock split; a 200 percent dividend constitutes a 3-for-1 stock split. Stock splits offer several advantages to a company, potential investors and existing shareholders.
Boost Investor Demand and Stock Price
A company typically splits its stock when it becomes expensive -- after it has risen. Investors are attracted to a rising stock price; a stock split often gets them excited and boosts their buying because in their eyes it confirms a company's success. A lower post-split price makes a stock more affordable to small investors who like to buy shares in round lots (100 shares). A small investor may not have $6,000 to buy 100 shares of a $60 stock, but when a split reduces the price to $30, he may buy a round lot. Additional investor buying may push the stock price further up.
Attract Institutional Investors
Companies prefer when their stock is owned by institutional investors because institutional ownership adds price stability, lends credence to the company and also can boost the price if an institution recommends the stock or decides to build a large position in it. An institution will only buy a stock when it can obtain it in sufficient quantity. Some small companies have too few shares outstanding -- issued and in the hands of investors -- so institutions cannot buy them even when a stock is an outstanding performer. A stock split increases the number of shares outstanding so institutions can start buying it.
Some stock investors see a more sinister side of stock splits. No stock rises forever: at some point it tops, turns around and begins to decline. Large long-term professional investors, insiders and institutions want to cash in their profits by selling, or distributing, their shares to small amateur investors attracted by a long rise. Making the stock more affordable to small investors can facilitate distribution.
Stock Price Indicator
A stock split in a rising stock is normal and expected but excessive splits (three or four splits over a short period of time or a 5-for-1 split) are often an indication that a run may be over soon and a signal to astute investors to start selling to lock in their profits.
- "How to Make Money in Stocks"; William O'Neil; 2009
- "Stan Weinstein's Secrets from profiting in Bull and Bear Markets"; Stan Weinstein; 1988
- "How to Make the Stock Market Make Money for You"; Ted Warren; 1966
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