Hi Phil,
How's it going?
Let's talk about splits.
Why does a company split its' stock anyway?
Well, there's a number of reasons for splits. The first is that it lowers the price that appears in the daily papers. A $25 stock isn't perceived to be as expensive as a $50 stock. Of course, this is a mistake on the part of the investing public, because how expensive a stock is or is not, isn't determined by the raw price per share. Most "experts" would say that when you're buying a stock, you're buying into that company's future earnings. Therefore, the P/E ratio might be the measurement of choice to determine how expensive a stock really is. There are also other ways (or measurements) to determine the relative expensive of any given stock. P/E is merely one of the more popular measurements.
Secondly, many companies are well aware of which institutional investors (mutual funds, pensions, etc.) own their stock. In particular, many of the mutual funds have defined in their prospectus exactly what type of stocks they're willing to invest in. Let's take Fidelity Low Price Stock Fund as an example. Their mantra might dictate something along the lines that they can only invest in stocks with a raw dollar price of $50 or less. (I just grabbed this number; I don't know their true levels off the top of my head.) If the company stock is already at that $50 level, then they "know" that Fidelity Low Price Fund is likely to be a seller in the near future (in order to stay true to the fund's objectives), and selling pressure might lower the price of the stock. However, if they split (say 2:1), then the new $25 price would allow the stock to stay in the Fidelity fund. The fund may choose to sell a portion of the company stock (post split) for any number of reasons, but the fund wouldn't be forced into that decision.
Another reason for splitting has to do with demand. The price of a stock rises to higher levels because there is a demand for that stock within the investing community. If the company determines that there are too few shares in the float to reasonably satisfy the demand for their stock, the company has a number of available options open to them. The first choice is to have a secondary offering. The down side of this choice is dilution of value to existing shareholders, and a secondary offering would require shareholder approval, which may or may not be approved. The second available choice is to offer a stock split, either as a true split or a split in the form of a dividend. While splits also require shareholder approval, they are much more likely to be approved because they're more favorably perceived by the existing shareholders (no dilution to worry about). So most established companies, given their choices, would favor a split over a secondary offering. Younger, growing companies might favor the secondary offering because of the capital infusion they would realize from the secondary offering. A third choice available to the company is to have insiders sell some of their insider holdings into the float. While this choice would increase the number of available shares, the down side risk is that insider selling is perceived as a negative indicator of the future value of the stock, and that perception might result in a wave of selling. (Witness some of the Internut insiders that sold into overvaluations.)
This is getting too long, so I'll close with this little tidbit of trivia I read somewhere in the past year or two. Actually most stocks appreciate by an average of 3% in the near term following the split. But the gain is short-lived as most stocks settle back into their pre-split measurement levels (for example P/E or Price to Book).
Have a good evening...
KJC |
