Stock Split

A stock split typically occurs once a company's stock has reached a certain price.

The price for splits may be predetermined and the aim may be simply to bring the price of stocks down so that common investors are more willing to buy. One of the reasons for a split is simply that stock prices have become so expensive that few people are able (or willing) to buy the stocks. This has an immediate and long-term effect on the price of stocks.

Most people simply aren't willing to buy stock when a single share is a hundred or more dollars. The company in question decides when the stock will split and what the ratio will be. Note that many companies choose to simply double the number of stocks during a split, but that's not always the case. Many different ratios can occur. So should you bail out when a company is approaching a stock split?

It's actually a pretty good time to be part of the shareholders. Consider this scenario. A company splits stock at a 2 to 1 ratio. That means that they've now doubled the number of public stock they have available. But it doesn't mean that they're suddenly offering new stock for sale to the highest bidder. It means that the number of stock you have has now doubled. What does this do to the price? The company's stock value must remain the same immediately after a stock split.

In the previous situation, consider that stock sold for $100 each before the split. After the split, the stock may be valued at $50 each. You have twice as many stock as before the split, so the total value of your stock remains constant. The advantage for those stockholders immediately following the split is that people are accustomed to seeing stock at $100 per share and many will be looking to buy into the company which in turn may push the price back up to $100.

Some people claim that the split is incredibly beneficial to stock holders. This is the reasoning behind that statement. The price of stock prior to the split may have been stagnant for some time simply because of the higher price of the shares. Traditionally, the price of stock that was recently split will climb again fairly quickly, increasing the value of your stock more quickly than before the split.

Others say that the price of the stock would have continued to rise without the split and that's there's no merit to the idea that people are less willing to pay more for a share of stock. While a 2 to 1 split is certainly one of the most common ratios for a division, some companies predicting quick growth will split at 3, 4 or even 5 to one. Stocks with a smaller or slower predicted growth may split at something less than 2 to 1 - 3 to 2, for example.

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