Toll Brothers (TOL) split recently. What the heck is a "split," why does it happen, and what does it mean for the stock?
In a split, the company issues one or more additional shares for each share already outstanding. Usually it's a 2-for-1 split, which means investors who have 100 shares suddenly find themselves with 200. (There are also 3-for-2 splits and 10-for-1 splits and various other permutations, but 2-for-1 is the most common.) Since the company's prospects haven't otherwise changed, however, each share is now worth half what it was worth before the split.
Companies do this for a couple of reasons. First, a lot of individual investors feel that a stock over $100 (or some other arbitrary price, but $100 seems common) is "expensive," so reducing the per-share price to under that threshold makes more people willing to buy the stock. Obviously the per-share price shouldn't matter one bit; what really matters is how much of the company you're getting for your dollar. That stays the same in a split, so the stock isn't really any cheaper; you just get half as much ownership per share as you did before, and twice as many shares. Still, people can be silly, and if they're more willing to buy, it increases liquidity (i.e. the number of shares being traded), which can be slightly beneficial.
Another reason companies may announce a split is simply that it's a sign of a growing company with a rising stock price, i.e. it is like a peacock's tail that shows off the company's health. In other words, it can be a PR move to draw attention to the company's recent achievements.
Last but not least, it's my understanding that occasionally, dividend-paying companies will split the stock as part of a substantial dividend increase. If they're paying $1 per share, and the number of shares doubles, a $1 per share dividend doubles too. If they were going to double the dividend anyway, a stock split can allow the company to continue saying "we pay $1 a share dividend." (Since the stock is half the price, the yield as a percentage doubles, just as it would if they had just increased the dividend to $2 a share.) I am not an income-oriented investor, so I don't know how common this is or, really, whether it's even true.
Not all companies have stock splits. Berkshire Hathaway (BRK.A) has never split and now trades at more than $85,000 a share. As a result, BRK.A is owned largely by professional investors and institutions (mutual funds and the like) -- most ordinary individual investors are loath to put so much money into a single share of a stock. (Berkshire also has a B-class stock, BRK.B, that trades at a "mere" $2800.)
Google (GOOG), whose management reportedly admires Berkshire CEO Warren Buffett, seems to be taking the same approach; it's in the the $300 range, and since many stocks split when they hit $100, GOOG "should" have split twice and be trading around $75 with four times as many shares outstanding as it has. Sears Holdings (SHLD) is another one that's above $100 with no split in sight. Basically, if they're trying to emulate Buffett, you'll probably see few stock splits, though not all companies that don't split are emulating Buffett. A benefit is lower volatility in share prices; the pros aren't going to panic as readily as Main Street investors on bad news. However, because there are fewer potential buyers, there's less speculation in the stock and less buying pressure -- the highs won't be as high. Buffett and his ilk are fine with this, as they're not speculating. BRK.A is probably pretty fairly valued.
Stocks also sometimes have a reverse split, in which investors give up one or more share of stock for each group of shares they own (e.g. 3 shares become 1). This has the effect of multiplying the per-share price by, in our example, three. It should be called a "merge" rather than a "reverse split," but that's "genuine Wall Street gibberish" (tm Jim Cramer) for you. A company doing this is usually in real trouble; its stock price has likely tumbled and it is in danger of being de-listed from one of the major exchanges. There is a minimum share price of $5 for the NASDAQ, for instance, and companies have often executed hefty reverse splits to get above the minimum. I've heard of 10:1 and more.
Once it was not uncommon to see an "expensive" (on a per-share basis) stock achieve a nice rise in the week following its split as investors start picking it up just because of the psychological issues I've already discussed. Why did it largely stop? Well, if a "bump" on a split becomes a common occurrence, it becomes predictable, traders notice and start buying stocks upon announcement of a split in anticipation of the post-split rise. (Usually a company announces a split a few weeks before actually executing it. TOL announced its split on June 9.) The actual split is often anticlimactic, as these short-term traders sell off their shares to the clueless who are buying it because it now seems "cheaper" to them. This is an aspect of the "efficient market" hypothesis: anything that can be predicted about a stock's future price will be factored into the stock price as soon as it becomes known, because people will buy (or sell) the stock to try to take advantage of this foreknowledge.
It should be interesting to see what happens to TOL post-split. I will of course keep you up to date.
Posted by kindall at July 9, 2005 10:39 PM