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What Is a Stock Split

What is a stock split? Why do companies do it? How is it going to affect you as an investor? All these questions and more, answered here.

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For some reason stock splits bring up a lot of emotion in people. When a company announces a split, many investors scream in praise of cheaper shares. And owners of the company stock always seem to be a little happier, knowing they now have twice as many shares. But has anything really happened? Well, not really. A stock split is more an illusion than anything else.

A stock split is when a company increases its total share count by cutting current shares into proportional pieces. For example, say you own 10 shares of a company worth $10 each when that company announces a two-for-one split. After the split date you will have 20 shares worth five dollars each. Dividends will be cut proportionally, and so will earnings, book value and company worth. Valuation metrics will adjust accordingly. Nothing has really changed, just a slight of hand by the company. So why do companies issue a split?

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According to the Securities and Exchange Commission (sec.gov), often a company will split their shares because they believe the high share price has become a psychological barrier to potential investors. The lower dollar amount makes the shares appear more affordable.

How does it affect the retail investor: A stock split has very little real affect for the average investor. A split will increase liquidity in the stock, possibly tightening the bid/ask spread. (The prices you pay to buy and sell.) Also, it is commonly thought a split is a signal from management that they believe the business will continue to be good. Always a positive sign.

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