A stock split is simply increasing the number of shares outstanding and proportionally adjusting the share price to compensate that.
Here is an example: if a company announce that it will split its stock 2 for 1 in month from now, a month later, their stock were traded at 50$/share and after the split is done, the stock price will be 25$/share. If a company had 50 million shares outstanding, after the split was done, there will be 100 million shares outstanding. The most common splits are 2 for 1, 3 for 1, 5 for 4, 4 for 3, 3 for 2. Also there is a reverse splits, such as 1 for 2, or 1 for 3. In that case, the price goes up, but number of shares outstanding down.
There are several reasons why would company do a stock split. First reason is if stock price rise too much, some people wouldn't have enough money to buy even a one share (such as Berkshire Hathaway, which was at $8 a share in the 1960's, has traded as high as $190,000. This has created the welcome condition of a stable shareholder base). Also psychologically, if you have a stock that is traded at 25$/share and the other at 700$/share, the later one will "look" more expensive to average investors. So if company do a stock split, it brings it down to a more attractive level. Second important reason is that if you have lower priced stocks, their liquidity incises, and as a result bid-ask spread lowers. Third reason is if a stock is traded in a market where there is a high minimum number of shares, or a penalty for trading in odd lots (number of shares under 100), a reduced share price may attract more attention from small investors.
Here is an example: if a company announce that it will split its stock 2 for 1 in month from now, a month later, their stock were traded at 50$/share and after the split is done, the stock price will be 25$/share. If a company had 50 million shares outstanding, after the split was done, there will be 100 million shares outstanding. The most common splits are 2 for 1, 3 for 1, 5 for 4, 4 for 3, 3 for 2. Also there is a reverse splits, such as 1 for 2, or 1 for 3. In that case, the price goes up, but number of shares outstanding down.
There are several reasons why would company do a stock split. First reason is if stock price rise too much, some people wouldn't have enough money to buy even a one share (such as Berkshire Hathaway, which was at $8 a share in the 1960's, has traded as high as $190,000. This has created the welcome condition of a stable shareholder base). Also psychologically, if you have a stock that is traded at 25$/share and the other at 700$/share, the later one will "look" more expensive to average investors. So if company do a stock split, it brings it down to a more attractive level. Second important reason is that if you have lower priced stocks, their liquidity incises, and as a result bid-ask spread lowers. Third reason is if a stock is traded in a market where there is a high minimum number of shares, or a penalty for trading in odd lots (number of shares under 100), a reduced share price may attract more attention from small investors.
Effect On Historical Stock Price Charts:When a stock splits, many charts show it similarly to a dividend payout and they do not show a dramatic dip in price. For example, company have 500 shares of stock priced at $50 per share. The company splits its stock 2-for-1. There are now 1000 shares of stock and each shareholder holds twice as many shares. The price of each share is adjusted to $25. Based on this example you might expect to see the stock dropping from $50 to $25. If this whas the case, and average investor didn't realize that it was a stock split, he would think that some news cause this, and there would be a panic in the market because a stock dropped 50% in one day!
So what is done is something called adjusted close price. Adjusted close price will take all the closing prices before the split and divide them by the split ratio. So when you look at the charts it will seem as if the price was always $25. Later, when we come to real trading stuff and come to backtesting, you'll see why is it important to understand these corporate actions, such as stock splits and their effect on price data.
So what is done is something called adjusted close price. Adjusted close price will take all the closing prices before the split and divide them by the split ratio. So when you look at the charts it will seem as if the price was always $25. Later, when we come to real trading stuff and come to backtesting, you'll see why is it important to understand these corporate actions, such as stock splits and their effect on price data.
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