NOTE ON STOCK-SPLIT- 5/1:
What's the Point of a Stock Split?
There are several reasons companies consider carrying out a stock split.
The first reason is psychology. As the price of a stock gets higher and higher, some investors may feel the price is too high for them to buy, or small investors may feel it is unaffordable. Splitting the stock brings the share price down to a more "attractive" level. The effect here is purely psychological. The actual value of the stock doesn't change one bit, but the lower stock price may affect the way the stock is perceived and therefore entice new investors. Splitting the stock also gives existing shareholders the feeling that they suddenly have more shares than they did before, and of course, if the prices rises, they have more stock to trade.
Another reason, and arguably a more logical one, for splitting a stock is to increase a stock's liquidity, which increases with the stock's number of outstanding shares. When stocks get into the hundreds of dollars per share, very large bid/ask spreads can result. A perfect example is Warren Buffett's Berkshire Hathaway (NYSE:BRK.A), which has never had a stock split. Its bid/ask spread can often be over $100, and as of November 2013, its class A shares were trading at just over $173,000 each.
None of these reasons or potential effects agree with financial theory, however. If you ask a finance professor, he or she will likely tell you that splits are totally irrelevant - yet companies still do it. Splits are a good demonstration of how the actions of companies and the behaviors of investors do not always fall in line with financial theory. This very fact has opened up a wide and relatively new area of financial study called behavioral finance.
Advantages for Investors
There are plenty of arguments over whether a stock split is an advantage or disadvantage to investors. One side says a stock split is a good buying indicator, signaling the company's share price is increasing and therefore doing very well. This may be true, but on the other hand, a stock split simply has no effect on the fundamental value of the stock and therefore poses no real advantage to investors. Despite this fact, investment newsletters have taken note of the often positive sentiment surrounding a stock split. There are entire publications devoted to tracking stocks that split and attempting to profit from the bullish nature of the splits. Critics would say this strategy is by no means a time-tested one and is questionably successful at best.
Factoring in Commissions
Historically, buying before the split was a good strategy due to commissions weighted by the number of shares you bought. It was advantageous only because it saved you money on commissions. This isn't such an advantage today as most brokers offer a flat fee for commissions, charging the same amount for 10 shares or 1,000. Some online brokers have a limit of 2,000 or 5,000 shares for a flat rate, however most investors don't buy that many shares at once.
The Bottom Line
Remember that stock splits have no effect on the worth (as measured by market capitalization) of the company. A stock split should not be the deciding factor that entices you into buying a stock. While there are some psychological reasons why companies will split their stock, it doesn't change any of the business fundamentals. In the end, whether you have two $50 bills or one $100 bill, you have the same amount in the bank.
