Stocks splitting

Factual Questions
1

I know virtually nothing about stocks and bonds so I’m hoping you can tell me a thing or two about stocks splitting. What’s the purpose of it? If it’s a good thing, why is not done more frequently by more companies? I suppose there are criteria that make it something worthing doing by selected companies at specific times. What would those be? What’s the downside?

Today I received a letter from the ONE company that I hold stock in (it was a gift!). They’re asking me to support a planned 5 to 1 split. In addition to what I asked above, what determines the best ratio for a split? Why 5 to 1 and not 10 to 1? Why not 100 to 1?

Thanks!

2

A stock split is a way of keeping the price per share under control while also not screwing over current shareholders. In a 2-to-1 split, the stock price is halved but the value of each stockholders’ holdings remains the same.

3

Stocks must have a value above a certain amount ($1.00, IIRC) to remain listed on the exchange so if the price falls too low they may have to do this. Priced too high (like Bershire-Hathaway - $135,000.00) and most small investors can’t buy it but some companies are fine with that. There’s a middle ground in there where it’s easy for funds and individuals to buy a meaningful amount of shares to give them some flexibility, and not too low to appear cheap and failing.

4

A stock split simply lowers the price of a stock by increasing the number of shares. Using your 5 to 1 example, it would be exactly like you giving me a five-dollar bill and me giving you five one-dollar bills in return. Your money still has the same value, but now you have five pieces of paper rather than one.

Companies will split their stock to keep the share price from getting out of hand a scaring off potential investors. There are those who think this is a bad thing (Warren Buffet, whose Berkshire Hathaway stock now sell for $135,500 a share, and William O’Neill whose publishes Investor Business Daily), but most companies will split their stocks given the opportunity.

Generally speaking, it is seen as a good thing because the price of the stock has risen to a rather high level and the companies board of directors has faith that the price will continue to grow.

5

If the stock price falls too LOW they do a reverse split to make the price higher. So instead of having 2 shares each worth 75 cents you would now have one share worth a dollar fifty. If this happens it usually means the price has been falling and perhaps the company has fallen upon hard times.

A normal stock split is genrally an indicator that the company is doing well, that the price has been rising so that it has to split to keep the price per share in the affordable range.

6

You are thinking of a reverse-split. A regular split is when the price is lowered and the shares outstanding increased.

For example, in a 5-1 split, a person who owns one $10 share would then own five $2 shares.

As others have mentioned, the point of a split is to keep the share price reasonable. (Warren Buffet is a notorious dickhead about this issue which is why Berkshire doesn’t do splits.) Reasonable share prices mean anyone can invest, and also help provide liquidity for the stock.

7

Makes sense. Thanks for your answers.

As a follow-up question, I’d wonder whether there isn’t an optimal price (or fairly narrow range) which makes a stock most accessible to the most buyers.

In terms of attracting investors (i.e. so that “it’s easy for funds and individuals to buy a meaningful amount of shares to give them some flexibility, (but) not too low to appear cheap and failing”), I can’t see the difference between a stock that sells for $10 or $100. Is there any? The notion of an ‘optimal’ price must have been studied, no?

8

A forward split does provide some additional liquidity. For example, you bought 100 shares of xyz at 10.00 per share back in the dark ages. You’ll never sell those 100 shares.

Now, xyz does a 2 for 1 split. You now have 200 shares of xyz. You’re more likely to sell those 100 shares while keeping “your” 100 shares.

9

Obvious stuff (maybe) but stock charts will not show the split as a change in the cost of the security. They will adjust the chart by taking ALL the closing prices befor the spilt and dividing them similarly by the split ratio.

For example, although (IIRC) the Microsoft IPO was $24 per share way back when, it will show up on the charts as (IIRC) $0.06 since there have been 9 stock splits since the early 80s.

10

Many companies try to keep their share prices under $100. No idea if there really is an “optimum” price (I doubt it) but prices above $100 are often seen as “too high” by casual investors who may not be aware of the stock’s history.

11

Ah, the good ol’ days when stocks like MSFT and INTC would split every year or two. Damn, I miss those days! :slight_smile:

12

friedo is correct that most stock splits happen when the price tops $100.

In theory, there is no good reason for the price to jump around right after a split. In practice, a split often triggers a lot of jiggling. Don’t panic. It will settle down. On the other hand, if you aren’t aware a split is coming, you may have a yike moment to see your price has dropped to half or one-third what it was yesterday. With your heart pounding, you’ll scramble around for news of a split.

I once panicked at such a moment, and I sold my hundred shares. When my next statement came, I learned I still had 200 shares. :smack:

13

It’s been studied. You can count on it, and you can probably find some studies by Googling. But I’m betting the studies simply aren’t conclusive. If they are conclusive, they surely say that most casual investors are scared off by investing $5000 and only getting fifty shares. They shouldn’t be scared off, but they are. They much prefer to have 500 shares at $10. It’s not hard for them to imagine a $10 stock going to $20. Happens all the time, they say. But a $100 stock going to $200? How often does that happen? I think it’s because of investors who think this way that Buffet keeps Berkshire outa sight. He absolutely doesn’t want any novice investor, panicky and uneducated, getting involved as a shareholder. He doesn’t want investors who stroke their chin worriedly and say: Gee, eighty bucks! That’s really getting up there. Don’t think I can afford a company like that! Buffet doesn’t want to hear from you if you choose your investment based on the stock price, instead of the value of the company, its history, management, prospects, fundamentals, etc.

He used to have the Baby B, didn’t he? Last I saw, I think it was at $1,300 or so. But that was years ago. Is it still trading?

14

It’s true that there’s a lot of interesting psychology surrounding splits, which should simply be an accounting mechanism meant to keep prices within a practical range, and have very little meaning. It might actually be better if exchanges forced splits at high prices, and were more rigid about forcing reverse splits at low prices. It would remove all the guessing about what the company was trying to signal.

Buffet’s reasoning might have some validity, up to a point. However, when the price gets extremely high, he’s also denying small investors who are well aware of what a stock price actually means, but simply can’t afford a trade for the price of a single share - brokerages don’t generally deal in fractional shares. Given that he also apparently objects to schemes for brokers to do exactly that - manage trades of fractional Berkshire shares on behalf of their clients - one can easily suggest he’s being a dick. He did issue BRKB as a remedy for this, and I believe it can be DRIP’ed. However, with BRKB now trading at over $4K a stub, it’s got the problem, too.

In the old days, one could observe that people who couldn’t afford to trade in single-share increments of Berkshire simply did not belong at the table - they didn’t possess enough of an ante to get in the game of buying and selling individual stocks. Indeed, in those days it was possible to suggest that odd-lot traders of most stocks were idiots. With the advent of much lower brokerage fees and online trading, that simply does not hold water anymore. There’s still a lower bound where brokerage fees make it silly to be trading, but it’s MUCH lower than it used to be, and far below the price of a BRKB share, particularly for the investor of the type that Buffet ostensibly wants, who is intending to hold the shares for a long time.

15

I take that back. BRKB does not have a DRIP plan available, and has not paid dividends recently, in fact. Warren doesn’t believe in issuing regular dividends, either. He has said

Berkshire did once issue a small dividend. Warren is quoted as observing that he must have been in the bathroom when it was approved.

16

BTW, the opposite of Buffet’s attitude might be the curious behavior of Archer Daniels Midland at one time. ADM’s split history:

August 31, 1945: 3 for 1
May 2, 1970: 2 for 1
November 17, 1972: 2 for 1
November 16, 1973: 2 for 1
December 16, 1974: 11 for 10
November 18, 1975: 3 for 2
September 1, 1977: 105 for 100
September 1, 1978: 105 for 100
August 31, 1979: 105 for 100
October 31, 1980: 105 for 100
February 20, 1981: 3 for 2
August 21, 1981: 105 for 100
August 23, 1982: 105 for 100
August 22, 1983: 105 for 100
August 20, 1984: 105 for 100
August 19, 1985: 105 for 100
May 2, 1986: 3 for 2
August 18, 1986: 105 for 100
August 17, 1987: 105 for 100
August 22, 1988: 105 for 100
August 28, 1989: 105 for 100
November 10, 1989: 3 for 2
August 20, 1990: 105 for 100
August 19, 1991: 105 for 100
August 17, 1992: 105 for 100
August 23, 1993: 105 for 100
August 22, 1994: 105 for 100
November 4, 1994: 3 for 2
August 21, 1995: 105 for 100
August 19, 1996: 105 for 100
August 18, 1997: 105 for 100
August 24, 1998: 105 for 100
August 23, 1999: 105 for 100
August 28, 2000: 105 for 100
September 4, 2001: 105 for 100

As well as periodical larger splits, they annually split 105 for 100. If you investigated, ADM shareholders seemed to talk about liking this as a “taxless dividend”, which makes no sense on the face of it - very slightly cutting the pie into a larger number of pieces doesn’t change anything any more than doing it more drastically. But there is that psychological thing, and I also suspect that they could get away with that kind of split with a lot of buyers not noticing it. They would just notice a bit of a drop in the price, and decide that it was time to get in, pushing it right back up to its pre-split price. Sort of a sneaky way to inflate the multiple once a year.

17

The “optimum” price of a stock varies by the kind of company it is. A mature, blue-chip stock like IBM or ATT might like to have a value of over $100 while a startup might like to keep it under $20.

18

Yes, I know, but clearly I didn’t write my post carefully. :slight_smile:

19

As others have alluded to in this thread, there is a psychological effect to consider. In theory, share price is driven at the macro level by such factors as price/earnings ratios, debt, prospects, etc. The truth is, though, that small variations can be triggered by things such as the current weather, the proximity to particular price point (such a historical high or low, or some round number) or perceptions of a person. When I worked at a Wall Street brokerage in the 80’s, we were eternally amused to note that most volatile stocks took a tiny dip every time it rained in New York, regardless of any news or other mitigating factor.

As well, there was a time that split-lot trades were very rare. Securities are technically traded only in blocks, and partial (or odd) lots were only traded at the discretion of the brokerage house. As the usual lot size was 100, this meant that high share prices also discouraged retail or small investors from buying the stock.

20

Yes, 1/30th of a Class A share, BRK.B - It’s at a paultry $4,550 per share.