Stock splits happen from time to time, so it's important for us as investors to understand what they mean and how they might impact our investing decisions.
A stock split is when a company decides to exchange more shares of its stock at a lower price for stockholders' existing shares. So, what happens to a stock’s price when it splits?
Nothing actually, although, it’s going to look like something big happened. Stock splits don’t change the market cap, which is the market price of the stock on a given day multiplied by all of the shares, or the sticker price of a stock one single cent. Not a penny. All a stock split does is change the number of shares and the price per share. I repeat: this does not change the total value of all those shares by even one cent.
A lower stock price makes it easier to trade because the stock becomes more attainable for interested investors who may have been priced out of buying it in the past. Lower prices make it easier to find buyers than higher prices.
When a stock price goes over $100 a share, people start to think of it as “expensive” even though the price of the stock has nothing to do whatsoever with the actual market cap of the business. A business worth $1 million is worth $1 million whether there is one share worth $1 million or 1000 shares worth $1000 each or 1 million shares worth $1 each.
But how many buyers are out there for a single share of stock worth $1 million? Not very many. Let’s say there was one buyer. The owner of that single share might have to take a much lower offer simply because there is only one buyer. But if there were a million shares at $1, there can be lots of buyers. Lower stock prices make trading easier, which makes investors trade more often. Trading more often makes for higher stock prices.
The bottom line is that stock splits have no effect on the true value of a company. As Rule #1 Investors, we care about the value of a company, not its stock price. We don’t base our investments in a company on the price per share but instead look at the entire company as a real owner does.
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