“What do you think about stock splits?”
The above question, which I received recently from a friend, inspired me to briefly share my thoughts on stock splits below. His question comes during a time when many trustworthy, reliable companies are splitting shares of their stock, including Sony, Cintas, Deckers Outdoor, Yamaha Corporation, and others.
Have you asked for change for a dollar?
What you receive in exchange is worth the exact same as your dollar, but it’s in a different form. Essentially, this is what a stock split is.
For example, a 10 for 1 stock split is trading your dollar (one share) for 10 dimes (ten shares). On the day the stock splits, the value of the ten shares will be the same as the previous value of one share. There are also reverse splits where you trade 10 dimes for a single dollar bill. In either scenario, the balance of your portfolio will remain the same.
However, when a stock split takes place, there is often a temporary bounce. Why?
The reason many companies choose to split shares of their stock, in a forward split, is to make individual shares more affordable for investors. After a 10-for-1 stock split, a $400/share stock becomes a $40/share stock, which lowers the barrier to entry for new investors.
Potential gains from this action are like a sugar high and are not a long-term benefit. The value of a company’s stock will always come back to its fundamentals. Remember, earnings are the horse that pulls the cart.
You can always trade your dollar for dimes, but that doesn’t mean those dimes will become more valuable than the dollar you traded.