Stock Splits and How They Work

A family member is wanting to know how stock splits work.  So this is the topic we will be talking about today as it can get confusing.  Lots of people do not know if a stock spit is a good deal or not.  I have spoken about this in previous blog postings, but we are going to review all this again for those that still have questions and our new readers.

First lets talk about why a stock splits.  There are many different reason, but the big picture is money for the company.  Perhaps they are wishing to generate more money for a purchase, buy out of another company, hostile take over, filling purchase orders, expansions of the company, etc..  Buy splitting the cost of the stock it makes the stock purchase more attractive to potential new buyers.  These new buyers purchase the stock at a lower price that they can now afford thus generating money into the pocket of the company of the stock they just purchased.

But what about the old stockholders?  Those people that owned the stock for a long time?  Depending on the stock spit approved by the companies Board of Directors the old stockholders number of shares will increase by the split value that was approved.  Lets look at a common example:  Company ABC Inc. has an approved split at 2:1.  This means the old stockholders are going to get 2 new shares of stock for everyone they own.  Thus if you own 10 shares, you will own 30 after the split.  But, those 30 shares are going to be valued at the same price as the 10 shares you previously owned as the price of the stock is going to fall.  Then the hope is that the price of the stock is going to be more attractive to new buyers and that they will start buying the stock, putting more money in the pocket of the company and drive up the price of the stock value putting more money in the old shareholders pockets.

Also with a stock that is going to spit, there will be a cut off date established.  Meaning if you by the stock before the cut off date the company will split your shares too along with the old shareholders.  This is where it begins to get tricky and confusing to many people.  How do you know if you should buy stock and take the split?  And is it okay to buy after the split if I missed out?  Lets talk about this and hopefully answer these questions.  Both have the same answer as far as I am concerned.  However, with a positive calculation you would have made more money had you gotten in on the split.  So you ask, what is the calculation?  Well, it is pretty easy and it works for me.  I have only lost money one time using this calculation and it was not a lot of money that could not be easily recovered by moving on to bigger and better things.  So here is my key to success with a stock split.  First, NEVER follow or buy into a spit that is less than 2:1 as you are most often setting yourself up for disappointments.  If you happen to own the stock in your portfolio already and it splits at less than 2:1 that is okay, but don't buy into a stock at less than 2:1 upon the split announcement.  Any split to a stock already in your portfolio is a good thing so don't get me wrong here.  Okay so ABC stock is going to split 2:1, but is it a good buy before the split?  Here is how you make the odds most often fall in your favor.  Like I said this works for me and other financial advisors like the formula as well.  Lets say the stock is currently selling at $100 per share.  Look at the 52 week low.  If the split will take the price down when it cuts in half to $50 per and is below the 52 week low significantly, this is a good stock spit to buy into before the split.  So ABC has a 52 week low of $80 per share, after the spit the price will be at $50 per share.  I see lots of room for growth her to even get back up to the $80 per share Low for the previous year.  This is a buy for ABC stock.  Lets say the 52 week low is $58 per share.  Now ABC stock does not look so attractive.  The bigger the gap the better the buy potential.  Does this formula work 155% of the time?  Of course not.  But like I said, it is a solid formal and it only has failed me one time and my loss was basically pennies in what the formula has made for me in the past.  I sold that one stock at a small loss to invest the money into Apple which split 7:1 and is currently up 36% in my portfolio.  I think I made the right choice.  Follow the formula and the odds are highly in your favor.

I hope this information about Stock Splits will help out those that need a little more understanding.  Do understand this is a basic understanding of how things work.

Gus S.



Disclaimer: Make sure to review any information found on this blog site with your personal financial advisor before making any decisions. I am providing general information and not financial advise. I am not a licensed stockbroker or financial advisor.