Should A Company Split Its Stock
Have you heard of the term stock-split before? What do you know about them? Are they good for you or bad for you?
There are many a talking head speculating about whether Amazon.com will split its stock, because its stock price is over $1,100 per shares. Sometimes it sounds like they are implying that a split would be good for you. But is it? Let's look at a couple of the reasons people think it is good for you?
Dollar Gains
Some people (myself included, in my younger years) think that a split is good because it gives you more shares. Therefore, if the stock goes up by $1 per share, then you make $2 instead of $1. That sounds great!
Except, companies don't trade based on share price; they trade based on something called market capitalization. I know...what's up with the big word! This just means the value of the whole company. So, take the total number of shares outstanding and multiply it by the price per share and you come up with the market capitalization. So, although it is true that a share price increase of $1 per share is better if you have more shares, the bottom line is that this is an apples and oranges comparison. When a company splits its stock, the market capitalization is the same.
More Accessible
Some people will say that if the price gets too high, like Amazon.com, then smaller investors aren't able to purchase shares of the company. Bringing the price down helps people participate in the ups and downs of the stock.
While this may technically be true, most of us access our stock exposure through funds, like mutual funds and exchange-traded funds (ETFs). Funds take savings from many, many investors and purchase investments. By pooling everyone's money together, the price of each specific investment is not much of a concern.
Trading Reasons
There is a perception that the liquidity will fall if the price gets too high. I know, I used two jargon words this week! Liquidity is the ability of an investment to be sold for cash (i.e. liquidated), or for cash to be invested in the investment. When an investment trades more, it means there are more buyers and sellers trading the investment back and forth. If that's the case, then you or I can find someone to buy from or sell to pretty easily. If there are fewer people willing to buy or sell a particular investment, then it may be harder to trade that investment.
The idea is that a large share price will scare off people who can't afford to trade at such large amounts. But, for the same reason as above, I wouldn't worry about this. Large institutions are trading these investments back and forth all day, and most of us access these investments through funds.
Bottom Line
I wouldn't worry much if you hear talk of stock splits or reverse splits. These mean very little, and are neither good nor bad.
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