Split the Difference
by MF DowMan

At least once a week, a reader asks for advice on the message boards about buying a stock which is scheduled to split. "Should I buy before or after the split?" "Does it mean I automatically lose half my investment when it splits?" "Will the split in a DJIA stock raise the yield enough suddenly to push it into the Beating the Dow group?"

Our Foolish take on stock splits is that they are non-events. The only thing that changes when a stock splits is an arbitrary number---the price per share. The company hasn't changed. The company's revenues and growth haven't changed. The value of your investment if you already own the stock hasn't changed. Then what's the big deal?

Let's look at the mechanics of splits and why they take place. When a company declares a stock split---say a 2-for-1 split---on a set day, the number of shares outstanding double and each one is worth half of the previous price. It's exactly like going to the cashier with a $20 bill and asking for two $10 bills. You've still got $20; it just looks a little different. On the same day, whatever dividend the company regularly pays also gets cut in half, so the dividend yield (the dividend divided by the share price) remains constant.

If nothing's changed, then, why do companies split? It's a simple matter of psychology. When stock prices reach a certain level, companies feel that small investors are nervous about buying new shares. The theory is that an individual investor is more comfortable buying Hewlett-Packard at $60 a share rather than $120. So they split the stock to keep the arbitrary share price in a "comfortable" zone.

How does it affect the Foolish investor? There's no evidence to suggest that stocks either go up or down surrounding a split, so we ignore split announcements in favor of more fundamental issues like earnings growth and clean balance sheets. Yet there is one consideration worth looking into---sales commissions. Depending on the type of brokerage account you have, the commission price might change drastically when a stock splits.

For example, if you have a broker who charges commissions based on the price per share, your fee will be more to purchase the stock before it splits since the share price is still higher. If you have a broker who charges a fee per share, then you'll pay more after the split because your investment will buy more shares at the lower price. For the real tight-wad Fools, we use deep-discount brokers who charge a flat fee per trade, regardless of share price or number of shares. In that case, the stock split becomes a complete non-event.

Don't sweat stock splits. Despite what you may hear, they don't mean anything if you're investing Foolishly---that is, with an eye on fundamental evaluations and long-term growth. Fool on!