A stock split is when a company takes their total shares and divides them into multiple or less shares. The total dollar amount of the stock does not change, just the number of shares you hold. The overall price of the stock then lowers or increases depending on the size and type of split. Take for example a 2 for 1 split for a stock trading at $100 per share, this means that you get 2 shares for every 1 share you already own. Alongside the shares doubling, the price is cut in half. So, if you owned say 100 shares at $100 per share ($10,000), you would now own 200 shares at $50 per share (still $10,000).
The main purpose of a split is to lower the price of the stock so that it is more affordable as a whole and in what are called round lots. To buy 100 shares of a stock trading at $1,000 a share would cost a lot, but 100 shares at $10 a share is quite afforable. The best example is Microsoft
Types of Splits
There are two types of splits:
A Standard Split: Your average stock split occurs when the stock price becomes too high and the company wants to lower it. These stock splits are good for the company overall because it shows that they have been growing and their stock price has been steadily on the rise. A standard split can occur with any magnitude, meaning the stock could split 2 for 1, or split 10 for 1, it all depends on the situation.
A Reverse Split: These splits occur when the stock price is so low that the company has to perform a reverse split to get its stock price back up, which is typically over $1 a share to meet listing requirements so it can stay publicly traded. These are a bad sign for the company as a whole and means the stock price has been moving to the downside. A reverse split can also occur to any magnitude, so the stock could split 1 for 2 or 1 for 10, again it all depends on the situation.
Investor Strategy With Stock Splits
The overall strategy is pretty simple when it comes to splits, stay away from reverse splits and look highly upon regular splits. If a stock you own has split three times in the last two years, you can bet the stock has been on the rise price wise over those two years.
The Bottom Line
There are two types of stock splits, a regular split and a reverse splits. Your standard stock split is a positive sign and not only means the stock has performed well over the last several months, but may continue to head higher in the future. Reverse splits on the other hand are a sign that a company may be on its last legs and its stock has not been performing well at all.
You can get a quick gauge of a stocks performance over the last few years by finding out their most recent split and the size of the split. If a stock has had a reverse split in the last two years, you are better off simply staying away. If a stock has had a great price run over the last year or more then has an even greater price run and splits 3 for 1 or more it may be a sign that the stock is getting close to a topping out.
Stock splits can be an investors dream and also their worst nightmare, it is a matter of how well you know the stock and how well you can gauge its future.