Stock SplitsA stock split is the process of decreasing (sometimes increasing) the share price of stock and making a proportionate increase (decrease)in the number of shares owned. The most common stock splits are 2:1, 3:1, or 3:2. The actions for these two situations are summarized below:
Companies do stock splits for three reasons:
An Example: Amazon.comConsider the following example. My daughter was fortunate enough to have bought 100 shares of Amazon.com (AMZN) shortly after the IPO at a price of $18 per share. The price of the stock rapidly appreciated to $240, and in June of 1998 the stock split two for one, and she had 200 shares. She then sold one-half of her shares at $120 per share and held 100 shares. Then she sold 50 shares and held 50 shares. In January of 1999, the stock split again, but this time the split was 3:1, and her number of shares increased to 150. All the while, the public share price was changing accordingly. As of February 1999, she held 150 shares with a market value of $120 per share. If she had not sold any of her shares along the way, she would be holding 600 shares (100 x 2 x 3).Now the question is, what did she really pay for the 150 shares that she holds? We know that originally she paid $18 a share for 100 shares, but now she owns 150 shares after two splits and two sales. The price she really paid for her current 150 shares is called the "split adjusted price" or the "basis price." The split adjusted price for my daughter's stock is her original price of $18 divided by two for the first split and then divided by three for the second split, which gives a basis price of $3 per share. That is, she paid $3 per share for her 150 shares which are now trading at $120 per share. This is why people get excited about stock splits. It usually means a company and its stock are doing really well, and the share holders are making money through stock appreciatioin. It gives us the impression that we are getting something for nothing. Something everyone likes. Reverse SplitsEarlier I said that sometimes the share price will incease. Let me give you an example. I owned some stock in small software company called Computer Concepts (CCEE). I bought the stock because I knew the CEO, as it turns out not a very good reason. I bought the stock for approximately $10 per share. The company did poorly, and the stock decreased to $1 and languished there. Stocks which trade near a dollar or below are called penny stocks and are considered highly speculative. In fact, most mutual funds will not buy stocks below $10 per share, which brings us to the reverse split.In an effort to give a stock more respectability, a company will often do a reverse split. A reverse split occurs when the share price increases and the number of shares decreases. In the case of CCEE, the split was 1:10. The share price increased to $10, and the number of shares decreased by a factor of ten. I am sorry to say that the stock now trades around $2, and my split adjusted price is $100. This is not how it is supposed to work. Berkshire HathawaySome stocks, but not many, never split. The classic example is Berkshire Hathaway (BRKA) founded by Warren Buffett. The stock reached a high in 1998 of near $90,000 per share and now trades around $70,000 per share. I remember first looking at BRKA when it traded at $11,000 per share and couldn't bring myself to buy one share of stock for such an astronomical amount of money. I finally bought one share in September of 1998 for $60,000. Better late then never. Warren Buffett is considered by many people (including me) to be the greastest stock market investor of the past fifty years. His philosophy is discussed extensively elsewhere in this book. The annnual reports of BRKA are written by Warren Buffett and are required reading for any serious investor or business owner. BRKA has one of the most understated web sites on the Internet. He is all substance and no flash, my kind of web site. Check it out. |