Today at TILE: Splitting Stocks

March 30th, 2011

Today at TILE we talked about “stock splits” – how companies use basic math to dress up (or dress down) the way their stocks look to investors. Why the need for mathematical gymnastics? Can a stock really change its stripes? Why does it matter?

A stock split occurs when a company decides to exchange a single share of stock into more than one. For example, say you own one share of stock in Widgets ‘R’ Us (let’s use WRU as the ticker, or symbol) and the company announces a 10 for 1 stock split. That means that for every one share you own, you will now receive 10 shares. Free money you say? Unfortunately, no. At the same time that you’re getting more shares, the price of the stock is dividing by the same amount. So, if WRU was priced at $100 per share, after the split each share would be worth just $10. The total value is the same (1 share x $100 each = $100 AND 10 shares x $10 each = $100) – it just looks different. Think about cutting a cupcake into four pieces. It’s the same amount of cupcake in the end (and the same number of calories), just a little easier to eat.

Why would a company want to split its stock into different “packaging?” Well, similar to other products (like soda or snacks), it is often easier to purchase something in smaller portions with a smaller price tag. Would you feel better about buying 1 share of stock for $100 or 10 shares for the same amount? The $10 is probably an easier price tag for most investors to swallow. Think about it the next time you go to (or drive past) McDonald’s… would you rather buy a Happy Meal for $4.00 or the burger, fries, drink, and prize each for $1? It’s the same thing, just different packaging.

In the spirit of marketing, sometimes a company might to do just the opposite, called a “reverse stock split.” Let’s assume things haven’t gone so well, and a company’s stock is selling for the low price of $4 per share. If the company wants to send a different message to investors (i.e., “our stock is valuable, not cheap”), it may decide to exchange every 10 shares for one. In this example, the 1 share becomes worth $40 (versus $4) but you own fewer shares. Basic math says the total value is the same, but the way you get there is a little different (10 shares x $4 each = $40 AND 1 share x $40 each = $40).

What does this mean for the TILE Community? As the stock market stabilizes and (hopefully!) continues its upward trajectory, many firms may take a moment to step back and assess their attractiveness to new investors. As they try to attract people like you to buy their shares, you may see more of this in the news and the marketplace. Would you feel better about owning a $40 share of stock than a $4 share? Or about buying 10 shares of $20 stock instead of 1 share of $200 stock?

It isn’t exactly like buying soda in different sizes, but at the end of the day, Coke is Coke no matter how large or small the packaging. Thus when considering stocks to add to your portfolio, the most important thing is to look inside the packaging to make sure you understand and feel good about what you’re really buying.

- Amy

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