While companies will usually do everything they can to make their stock price rise higher and higher, there is one premeditated event that is motivated by a desire to lower the stock price: the stock split.
The Basic Split
The classic stock split involves a company declaring that it will give more shares of its company in exchange for existing shares. For example, a company with 1 million outstanding shares may declare a 2-for-1 stock split, and give all shareholders two new shares in exchange for every one share they currently own. As a result, there will be 2 million new shares in the company instead of the 1 million old shares.
Stock splits can exchange any amount of shares for old shares, with 2 new shares for every 1 old share the norm. Still, 3-for-1, 4-for-1, and even 10-for-1 or 20-for-1 splits have happened in the past. More uncommon ratios, like 6-for-5 or 5-for-2 are possible as well.
After a split is announced, it will become effective on the ex-date. In other words, all shareholders who own stock before that date will be eligible for the split. On and after that date, the new amount of shares will take effect.
Reverse Splits
While basic splits result in the increase in the number of shares on the market, the opposite is also possible. This is when a company says that it will recall old shares and exchange them for a lesser number of new shares.
A recent and notorious example happened in 2011 when Citigroup (NYSE: C) decided that it wanted to increase the price of its shares. Throughout the 1980s and 1990s, the giant bank traded at prices similar to other major banks. At the end of the 1990s and in the first decade of the 21st century, it traded for well over $20 per share, peaking at $55 per share in 2007. In the subprime mortgage crisis, Citigroup was hit harder than most, and its shares fell over 93% in value within a little over a year. This meant that the stock was trading for less than $3 per share.
In an effort to raise the price of the share to make it qualify for certain types of institutional ownership, the company decided to do a 1-for-10 reverse split in early 2011. This raised the cost of the shares to $45 per share instead of its price at the time of $4.50. Since then, shares have fallen by about 50%.
Reverse splits are usually signs that a company is attempting to appear more valuable, and investors rarely look at the news as a good sign. An even more worrying sign is when a company does a reverse split to avoid being delisted from an exchange, which can happen if the shares fall below a minimum price for a certain period of time. The New York Stock Exchange, for example, hasĀ a minimum listing price of $3.
Impacts on Price
Since a 2-for-1 split results in twice as many shares for half the price, this does not indicate a change in share value. The price has changed for the stock, but the value has not; each individual unit is worth half as much, but there are twice as many units. A stock split, theoretically, is just a different way of dividing up a company’s value, so it should not have a direct impact on the value itself. If I have a pizza and make four or eight slices, it doesn’t really matter; I still have a whole pizza, just the pieces are smaller. Same with stock splits.
In reality, splits do not have a neutral effect on share value. Reverse splits often show real crisis in a company, and splits represent optimism that a stock price is going to continue to rise. If a share price continues to rise indefinitely, it will quickly become unaffordable. A good example is Berkshire Hathaway, (NYSE: BRK.A); one share in the company costs a little over $128,000. In the 1990’s, however, a stock in the company was a more affordable $7,000. If Berkshire Hathaway offered a 100-for-1 split, shares would fall to a more reasonable $1,280 and allow more marketplace participants access to the shares. Until then, investors need to satisfy themselves with class “B” shares (NYSE: BRK.B) to invest in Warren Buffet. Those shares are a more reasonable $85.35 per share.