Why do Stocks Split?

Today's topic covers stock splits: What are they and why are they done.

E-mail Question from Member:
Chris -
Here's the question: I'm curious to know why some companies chose to split their stock (like HANS), while other companies chose to allow their stock to run (like GOOG). Is there any rhyme or reason as to why some managers chose to split and others don't?

My Answer:
I will start by giving a brief definition of a stock split for those of you that are unfamiliar with the term. Every company that trades stock publicly has a set number of shares that are outstanding. A stock split is a decision by the company's board of directors to increase the number of shares that are outstanding by issuing more shares to current shareholders. I will use Hansen Natural (HANS) as a recent example of a stock that split in 2005 while on our screens. I originally started coverage on the stock near $66 in May 2005 before a 2-for-1 stock split that took place in August of 2005. If you were to look at a current chart for HANS, the price in May 2005 would show you a number in the $30 range (half of the original price) due to the split. When a split takes place (in this example), every shareholder with one stock is given an additional share. So, Hansen Natural had approximately 11 million shares outstanding before the split and it now has 22 million shares outstanding after its 2-for-1 split. If you owned 100 shares near $90 when it split, your account would be adjusted to 200 shares near $45.

As investopedia.com states: One share represents the value of the company's underlying assets plus its growth potential divided by the number of outstanding shares. After a stock split, the only value that changes is the denominator in the equation. After a split, the stock price will be reduced since the number of shares that are outstanding is increased. In the example of a 2-for-1 split, the share price will be halved.

So why does a company want to split its stock?

Most individuals and small investors believe that a stock is more affordable at a lower price and they will only buy if the stock seems reasonable. Currently, Google is trading above $400 per share; so many investors will not buy this stock because they believe it is too expensive. In all actuality, 100 shares at $400 are the same as 400 shares at $100. Buying Hansen at $100 per share in August was actually cheaper than buying it now at $83 because the $83 is actually worth $166 before the split. Another reason for a split is a clue to the market that the growth in the company is expected to last (this is an assumption that the company’s directors make when asking for the split). When the board decides that a stock should be split, they send a voting ballot to every shareholder to make the final decision. I have voted in these ballots and ironically, the first stock I ever bought in my life split 2-for-1 (I thought I was important because I had a say in the stock).

Some stocks have split two or three times in one year (especially if you go back to the heart of the 1999 bull run) and some stocks don’t like to split such as NVR (a home building stock), Google and the most famous: Berkshire Hathaway, owned by the second richest man in the world (Warren Buffett). The current price for BRK-A is $88,600 with a 52-week range of $78,800 - $92,000. To buy 1 share on the open market today would cost you $88,600.

So, a stock split is used primarily by companies that have seen their share prices increase substantially. A stock split increases the number of outstanding shares and therefore decreases the price per share. This helps makes the shares more affordable to small investors and provides an indicator of the health of the company.
Piranha