Page 106 - May 2022

FINANCIAL PLANNING
Have you ever seen on the news that a company is announcing a stock split? This is relatively common for companies to do. A
company may choose to split their stock to lower its trading price to a range that is more affordable for investors, and to increase the liquidity of trading in its shares. Hearing that a stock you own is going to split can be an excit- ing event. In this article, I want to talk about stock splits and how they could affect you as an investor. I also have a couple examples to illustrate what could have been for almost any long-term investor.
WHAT IS A STOCK SPLIT?
As I briefly touched on above, a stock
split is a way to lower the trading price of the stock. If you own one share of XYZ company and they announce a 4-for-1 stock split,
you will now own 4 shares. The common misconception by investors is that this will make you rich or increase your ownership in a company. This is false. An easy way to explain this is over dessert. If you have one pie and you slice it up into four pieces, you still have the same amount of pie. Some people assume that you would now have four pies due to the split. The amount of pie doesn’t change, just the number of pieces you have. When a company is doing well, the share price will go up. It’s especially common for tech companies who
have seen massive growth in previous years. The price of one share can get up into the thousands of dollars and it might turn smaller investors away. When the stock splits, the
share price is decreased, and smaller investors tend to see this as a buying opportunity. Psychologically, this could cause the share price to go up. Investors tend to think that when a company announces a split, the price is going to increase, which may cause them to invest in the company. Two things to keep in mind is that when a stock splits, the price of one share is more affordable, and investors get the idea that the split will result in the stock performing well. The actual value of ownership you have in the company won’t change, just the number of shares. The per share price decreases by a like amount.
NEWS ON STOCK SPLITS
You may have heard about Amazon splitting its stock 20:1. As I write this article, Amazon is trading at roughly $3,400 per share. Not exactly an affordable stock for most investors. I’d like to do a quick calculation to show the significance of this stock split. I’m going to use a round number of $3,000 per share. If we are splitting it 20 times, the share price will be $3,000 divided by 20, which equals $150 per share. After the split, we have 20 shares instead of one. The share price will
then decline to $150 instead of $3,000. Taking $150 and multiplying it by 20 shares will still give us our original $3,000 investment. As you can see, the total value isn’t going to change. In my opinion, the most exciting part of a company choosing to split its stock is that it usually means the company is doing well. This is good news for you as a stock owner.
Recently, Tesla announced that they are going to be splitting their stock again. If
you own Tesla, this is a reason to be excited because it means the company is doing
well. Often, when a company announces a stock split, you will see a jump in the share price. This goes back to that psychological advantage that I mentioned previously. Investors think this announcement means the price will increase so they buy shares, causing a spike in the price. There’s also a possibility that there will be a jump in the price when the stock split becomes official because the share price becomes more affordable.
Reverse splits are just the opposite. Say a company is trading at $10 per share and the board announces a 1-for-4 reverse split. This
is done to push the price higher to attract professional and institutional investors. Again, we need to remember to also calculate the split on the shares and the share price. So, if we owned 100 shares before a 1-for-4 reverse split, we would own 25 shares post-split.
ALL ABOUT STOCK SPLITS by Cade Peterson, Financial Planning Associate
104 SPEEDHORSE May 2022