During bull markets, we see an increase in the number of companies that announce a stock split. Fundamentally, a stock split really doesn’t change anything. The value of a company does not change. The value of shares held by investors does not change. If an investor held 100 shares of a stock for $150, they would hold $15,000 worth of stock. If a 2 for 1 split occurred, an investor would now hold 200 shares valued at $75 for a total of $15,000. A 3 for 1 would give the investor 300 shares at $50 for a total of $15,000. So why do stock splits even occur?
There really is only one reason to have a stock split. The reason is to lower the entry price for potential investors in the stock. A great example would be to look at Berkshire Hathaway class A shares. Today, those shares closed at $206,000 per share. That is the price for 1 share. Since you are not able to buy ½ shares or fractional shares, an investor would need a minimum of $206,000 to invest in 1 share. Obviously, that would price a lot of investors out of ownership in those shares. If the share price were even a few thousand, more investors could purchase the shares. A share price in the hundreds would open up investing to even more potential investors.
Any company loves to see share prices increase since it represents value to shareholders. When prices start to keep investors from investing, a company will consider doing a stock split. Although a company can split shares however they choose, the more common split amounts are a 2 for 1, 3 for 2, or 3 for 1 split.
Since the intent of a split is to create a greater demand by opening trading to a larger group, we wonder if the desired result occurs after a split. One study done by David Ikenberry of Rice University looked at 1275 stock splits from 1975-1990. He found that split stocks outperformed non-split stocks by 8% after 1 year and by 16% after 3 years. Of course, it could be assumed that the company has good fundamentals if the price has been rising, so that alone could cause a company to outperform others.
There are numerous sites you can check to see companies that are splitting. One free one is Stock Splits.net. http://www.stocksplits.net/splits.htm
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