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Stock splits are the partitioning of the outstanding shares of a corporation into a larger number of shares, without affecting Stockholder's Equity or the total market value of the stock.
For example, if a company declares a 2-for-1 stock split of its stock, of which has a current market value of $100/share and 100,000 shares outstanding, the following results occur:
| Pre-split:
Outstanding shares 100,000
Market Value
$100 Market capitalization $10,000,000 |
Post-split:
Outstanding shares 200,000
Market Value
$50 Market capitalization $10,000,000 |
Essentially, in your standard 2-for-1 stock split, the company's outstanding shares are simply doubled and the stock price is divided in half. Notice, the market capitalization, or market value of the stock, remains the same at pre- and post-split conditions. This is because stock splits have no impact on the value of a company's stock. A stock split is merely an accounting transaction in which no equity is exchanged. Also, these splits occur in different combinations (2-for-1, 3-for-1, 3-for-2, 5-for-4, etc.).
There are numerous explanations, although research indicates that, for the most part, stock splits have a positive affect on the stock price. Rice University professor, David Ikenberry, conducted a study of 2,750 companies from 1975 to 1990, which found that, on average, shares rose 3.4% in the days just after the stock split. Moreover, Ikenberry's study showed that, over a three year period, split shares outperformed non-split shares: by 8% in the first year after the split, 9% the second year, and 12% in the third year. (see graph).
These results show that, over the long term, stock splits seem to have a considerable effect on the company's stock price.
Although stock splits have no direct effect on a company's equity, the event of a split does forecast hints and signs of how the company is performing. Companies usually tend to split their shares when the company has an optimistic view of its future and operations. The announcement of a stock split can be a symbol that a stock has attained a certain level of success, especially when the company declaring the split has had previous stock splits. The fact that a company has a record of multiple stock splits usually indicates that the company is among one of the faster growing firms, since their stock has been split numerous times. Generally, a company is motivated to split their stock to attract more investors with a lower share price. As a psychological influence, people would rather buy a stock at $30/share than at $60/share even though the cost basis will be identical. However, some people can only buy lower priced stock because they may not have the buying power to make a larger investment. Thus, they wait until a stock splits so they can afford some shares. Just because a company declares a stock split, it does not mean that the stock price will inevitably rise in reaction. There are many other variables that influence investors' decisions in the result of a stock split.
Companies also split their shares if they need to broaden their shareholder base and make more shares available to investors. A motivation for this could be a company's defense to a potential hostile takeover. Stock splits make the company more liquid, allowing more investors the opportunity to purchase an ownership in their company.
Now that we understand what stock splits are and what they affect and influence, the timeline of a stock split consists of four main dates:
The two key dates that are important to investors are the announcement date and the payment date. The announcement date is important because no one knows for sure if and when a company a will declare a split of their company's stock. Thus, investors speculate on whether the company will announce and when they will announce. The payment date is crucial as well because this is the day before the company actually splits its share price, after which investor activity changes as the new share price targets a different audience.
These different dates yield different stages of investor activity. The first and most speculative stage is the "Pre-announce or Candidate" stage. This involves speculation on when a particular company will announce a stock split. Most commonly, splits are announced by a company in their quarterly earnings report, but earnings season is the time when investors are least willing to invest their money because of the fear that the company might report lower than expected earnings. Sun Microsystems (SUNW) is a perfect example of a pre-split announcement run up. In 1995 and 1999, the company's stock price indicated distinct pre-announcement run-ups in value prior to its splits. An illustration of this stage is best illustrated in a 10-year chart of SUNW with its respective splits designated in the chart.
The other stages of the stock split cycle include the "announcement spike," the "post-announcement depression," the "pre-split run up" and the "post-split depression." All five of these stages hinge off of the announcement date and the payment date. Four other companies we investigated genuinely illustrate a blend of each of these other stages involving a stock split. The four stock chart links below each illustrate a different blend of these stages. Pay attention to the volume and stock price fluctuations before and after the actual split. There is usually a four- to six-week period before the split and approximately a two-week period after the split when these five stages are evident.
For more information on the five stages of a stock split go to www.split-trader.com. Also, CNET provides explicit information regarding stock splits. The site has a history of every individual company's stock splits arranged by date with listings of the amount of the particular split and announcement, payment, record and ex-dividend dates.
Most stocks seem to experience a significant rise in their share price before the actual split and the stock sells off after the split is executed. Although this may seem like a good rule of thumb, nothing is ever that easy. There are many other variables involved as well, including economic reports, market stability, earnings, interest rates, external conflicts, etc.
Moreover, there is another factor that engenders the announcement of a stock split. Companies tend to try to keep their stock within a certain price range. Therefore, when a stock hits the company's price target, the company, upon approval of the Board of Directors and the shareholders, will announce a stock split. From the research we have compiled on our five companies, these price ranges seem to vary between companies, but most companies do seem to cap their price range somewhere in the mid-100's. INTC, MSFT, and EMC have each split their stock when the share price reached ranges between approximately $130-160 per share; whereas, SUNW and ORCL announced splits at levels between $85-100 per share. Apparently, every company has their own idea of what price and when is most desirable to split their stock, but there does seem to be some degree of a psychological range where many companies seem to wait until, at least, their stock reaches $100/share.
The term, stock split, is one commonly referred to in the financial market arena, yet most people misuse and misconstrue stock splits and stock dividends.
These pages were created by Kris Rymer, Monique Kasisky and Mike Peragine.
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