 | J. Richard Coe, CFP®, CLU ,founded Coe Financial Services in 1983. Dick has been a Certified Financial PlannerTM practitioner since 1983 and a Chartered Life Underwriter since 1991. He is a Registered Principal with London Pacific Securities, Inc., a Registered Broker/Dealer, member NASD & SIPC and an Investment Advisor Representative of Coe Financial Services and London Pacific Advisors. He is a member of the Wichita Estate Planning Council, the Financial Planning Association, and Rotary Club of Wichita. You may contact Dick at Coe Financial Services at 8100 E. 22nd St. North, Building 1400-2 in Wichita, by by phone at (316) 689-0900 , or by e-mail at jrcoe@CoeFinancialServices.com |
Investments
2002-12-01 11:12:00
Stock splits
: Can you explain why some stocks split and some do a reverse split?
ANSWER: Would you rather purchase 10 shares of stock at $500 each, 100 shares at $50 each, 1,000 shares at $5, or 10,000 shares at 50 cents each? Your investment would be the same in each case -- $5,000. Many people would consider the $500 stock too expensive. Stock selling at 50 cents (which are considered penny/low-priced stocks) would often ring alarm bells, and some people would have less comfort buying a stock at $5 than $50.Assume the market value of a company is $500 million. If one person owned the company, it would not make any difference if 100% ownership was represented by one share or 500 million shares. The one share could be split or there could be a reverse split on the 500 million shares.Assuming there was only 1 share of stock, it would be worth $500 million. If the owner wanted to sell half the company, he could do a 2:1 split and sell one share for $250 million. Is the company worth more after the split? No.If the two owners wanted to sell their stock to the public they might sell 10 million shares through a public offering at $50 for a total of $500 million. Or perhaps they would sell 20 million shares at $25 for a total of $500 million or 50 million shares at $10 per share for a total of $500 million. The value of the company is the same, regardless of the number of shares.Would you rather have a dime or two nickels? Would you rather have a pizza cut in halves, quarters, or eighths?Just as a cut pizza may be more convenient than a whole one, $50 share prices may be more convenient than $500 share prices. Directors of publicly owned companies often decide to split their stock so that the price will be in a range that seems reasonable. Stocks split because of growth in the stock price. Stock splits do not make a company worth more.Stock splits may facilitate liquidity in the market since more people may own shares. There may be a tighter spread between the bid and ask as a result of a split. Perceptions matter, and there is something of a "hype" factor with stock splits. Usually splits are announced when the stock is going up and it is conceivable that the announcement reinforces positive views of the company even though the split itself does not change the value of the company.If a person had purchased 100 shares of Microsoft at the public offering price of $21 on March 13, 1986 and retained them, he would have 14,400 shares on December 13, 2002 through 8 stock splits. The original investment of $2,100 would have grown to $756,000.Recently another prominent company has been in the news because of a reverse split. AT&T's Board of Directors decided on a 1 for 5 reverse split, effective November 19, 2002. Because of the reverse split (which was coupled with a cash dividend) AT&T has 20% of the shares it did before the split. Those shares (with a December 13, 2002 price of $27.56), are worth 5 times as much as they would have been in the absence of the reverse split. The split or reverse split will probably reflect what has happened to the company. It is best to think of the split or the reverse split as a symptom, not as a cause.
