Stocks
Young Fools
March 25, 1998

Stock Splits

If you see a stock fall just about 50% in a day, you can be pretty sure it "split." In the case of ARF, the company split 2-for-1. That means that it doubled the number of shares outstanding, and cut the value of each share in half. (Sounds scary, doesn't it? It's not.) So if you owned two shares of ARF yesterday, you own four shares today. For each share you own, you got another one. Each share became two shares. That's a 2-for-1 split. In order to keep the value of the shares the same, their price is cut in half. So now you have four shares, each worth $25. Four times $25 equals $100. Exactly what you had yesterday. (Phew!)

With splits, the only things that change are the number of shares that exist (and that you own) and the prices of the shares. That sounds like a big deal, but it isn't, since the value of the company (and your investment) remains the same.

Before the split:
You owned 2 shares, worth $50 each. Total value: $100. (2 x 50 = 100)

After the split:
You own 4 shares, worth $25 each. Total value: $100. (4 x 25 = 100)

Stocks can split in lots of ways. It can be 3-for-2, 4-for-1, or many other ways. Why do companies split their stock? Well, imagine a great growth company. If its stock keeps rising, from $20 one year to $50 the next, to $85, then $140, then $200... people are eventually going to think it's too expensive for them. That's silly, because you can buy just one share at $200 instead of 10 at $20 -- it all comes to the same thing. But people are more attracted to lower-priced stocks. And a lot of folks incorrectly think that you have to buy 100 shares at a time.

Also, if some stocks didn't split, they'd be worth a lot more than $200, so splitting isn't such a weird idea. For example, if, in its 78-year history as a public company, Coca-Cola had never once split its stock, one share would be priced at more than $300,000 today. Not too many people today could afford a single share. (An interesting Foolish note: Coke has split so many times in its history that one share of its stock in 1919 when it went public has now become more than 4,600 shares!)

Another reason stocks split is to increase the number of shares outstanding. Imagine a company that only has 10 million shares available to trade. If more and more people, mutual funds and pension funds want to buy shares, there simply won't be enough. So by splitting, the company gets to increase the number of shares available.

Just remember that while a stock split does technically make a stock's price cheaper, it doesn't make it a better value. A stock like Wells Fargo bank might seem "expensive" at more than $250 per share, but it can represent a much better value than Bow-Wow-Oui, selling at $25. Stock prices only matter when you compare them to other numbers, such as earnings. In other words, don't compare stock prices of companies.

Stocks

What is Stock?
The Case for Stocks
Stock Prices and Value
How Do Stocks Move?
Dividends
What are Mutual Funds?
What are Index Funds?
Stock Splits