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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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