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Stock Splits

     Stock splits can be both profitable and give subtle guidance through the investment fog. Usually a company's board of directors has a price range they would like their stock to trade within. With strong earnings and product reports, accompanied by a robust market a stock can rise above that desired range. Most investors prefer to buy stocks in 100 share increments despite the general disappearance of hefty odd lot charges for orders of less than 100 shares. As a stock price becomes lofty fewer and fewer investors can comfortably buy 100 share lots of the stock. Thus when a share price gets higher than desired the company's board of directors will declare a stock split to bring the share price back into a customary range and increase the accessibility to the stock by the average investor. Stock splits are also used to increase the average daily trading volume of a stock.

    The typical stock split announcement contains the record date, the ex-dividend date, the payable date, and the ratio of the stock split. The record date is the day all recorded shareholders will receive the new shares. The ex-dividend date is the first day the stock will trade without a buyer being entitled to the extra shares. The payable date is the date in which the shares will trade at the split adjusted share price. The ratio of the split is frequently 2 for 1, or 3 for 2; and is sometimes written as a ratio like 2:1, or 3:2.

    What can we learn from stock splits and how can we profit from them? There is clear and subtle phenomenon associated with stock splits. The obvious first observation that can be made is that the share price has recently run up. That's great news! Stocks that split are usually seeing price appreciation. Some investors intentionally buy shares of a company just before they split to receive the extra shares and other investors intentionally buy the shares just after they split because the price seems more accessible. Either way there is an increased number of buyers of a stock around the time when it splits. Stocks can receive more media attention when they split. Boards of directors declaring a stock split often declare further splits in the future. Some high-flying tech stocks were split on 3 or 4 separate occasions in the 9 months prior to March 2000. Four 2 for 1 stock splits turns 100 shares into 800 shares. Research has shown shares splitting 2:1 tend to out perform stocks that split 3:1, 4:1, or 3:2, although this isn't a hard and fast rule. Another interesting phenomena is caused by the casual investor who is used to seeing his favorite stock around $50 and then, unaware of the split, sees it trading post-split at $38 or $42 and decides to pick up more shares because it is currently a bargain.

    The one nasty "split" that rarely has its intended outcome, and should flash a bright red light in your eyes is the reverse stock split. This is sometimes used to inflate a low price stock to make it more attractive to mainstream investors. A $20 stock may seem more acceptable to investors than a $4 stock. So the company does a 1 for 5 reverse split. Unfortunately the observed outcome is a share price that like the regular split tends to return to its pre-split price. Only in this case decreasing in value by 80%.

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