There’s been a steady stream of 2-for-1 stock splits in 2013 and upcoming in 2014. For instance, Canadian Utilities and CN split in 2013 and both the National and TD banks have announced a split coming up in early 2014. In each of these cases the stock’s price had risen either close to or over $100. It made me wonder why do companies split stocks and is there something magic about the $100 price mark that triggers a split?
Trading Shares in the Days Before Electronic Stock Exchanges
As I explained in Can I Buy or Sell a Small Number of Shares of a Stock, Say 18? you can buy or sell any number of shares at most online discount brokerages without paying any extra fees or penalties. You do have to pay the full trading commission even if you only buy or sell 1 share, though, which deters most people from flipping very small numbers of shares.
In the olden days, however, you almost always had to buy or sell shares in groups of 100. The package of 100 shares was called a “board lot.” It made person-to-person trading simpler. Selling a non-board-lot, called on “odd lot,” often cost more if it was even permitted. Not long ago, the trading commission on any lot used to be hundreds of dollars; most investors with enough money to justify the trading commissions also had enough money to afford to buy shares in multiples of 100.
(Stocks valued under $1 used to be packaged in lots of 1000 shares or more.)
Keeping the Value of a Board Lot Under $10 000
You can calculate that if a share of a company cost $100 and you had to buy a board lot of 100 shares, you would need to have $10 000 plus the trading fees handy.
This may be where the magic price of “$100 per share” came into the decision-making about splitting a stock. As the price rises above $100 per share, the cost of a board lot increases above $10 000. That may start to price the lot out of reach for some smaller investors.
If the company offers a 2-for-1 share split, each person owning 1 share is granted 1 additional share. For a routine split, the price of the shares and the dividend per share is then also split in half.
A 2-for-1 split would reduce the price of a board lot for a stock with an initial price of $100 per share or $10 000 per lot to $50 per share or $5 000 per lot.
That may increase the attractiveness of the stock to small investors, which in turn may encourage a further increase in the price of the shares.
Why Does It Matter What the Price is Per Share If Investors Do Not Have to Purchase Board Lots?
Now that small investors can purchase shares without buying them in board lots, it’s not clear to me why stock splits are still so common.
They obviously are not mandatory. Here are some examples of companies that haven’t bothered to split their stock to keep share prices low. Today, a share is trading at
- $ 535.39 for Apple
- $ 1 108.53 for Google
- $ 176 300 000 for Berkshire Hathaway A
What Do Companies Say About Splits in Their News Releases?
So what reasons did TD offer in their recent news release about their 2014 2-for-1 share split? From what I can read, they didn’t offer any justification!
Apparently it’s supposed to be “intuitively obvious” why the split is needed, to quote my first-year math professor who often used the phrase when describing saddle functions.
The National Bank did offer this explanation: “The Bank is undertaking the share dividend to ensure that its common shares remain accessible to individual shareholders and to improve market liquidity for the common shares.”
Canadian Utilities, which split its shares in 2013, said: “Canadian Utilities is undertaking the share splits to ensure that the Class A shares and Class B shares remain accessible to individual share owners, to increase and broaden Canadian Utilities’ share owner base and to improve market liquidity for the shares.”
Is a Stock Split Just a Mirage to Boost Prices?
When a stock splits by offering more shares at no cost to a person holding existing shares, the value of the corporation does not change. The total dividend does not change either. There is no tangible benefit to the investor because of the split.
So why does the price of a stock often increase after a split?
Logically, it should either go up or down just as it would have prior to the split based on the usual factors to determine the worth of a company.
Illogically, sometimes the price goes up not because of any real change in the value of the company but simply because of a change in perception of the same facts.
Sometimes new investors purchase shares in the company after a split because they seem “more affordable” The fact they could have purchased, say, 50 shares at the pre-split price or 100 shares at the post-split price and obtained the same ownership in the company’s future doesn’t seem to matter.
Also, sometimes investors see the split as a signal that the company expects further growth quickly in its share price. Again, that can result in new investment even though the split itself did nothing to change the company’s outlook.
Yahoo Finance does suggest that a split may make it easier to sell shares by reducing the price a buyer needs to offer. I guess it’s possible that it’s easier to find two buyers with $5 000 each than 1 buyer with $10 000 but I wouldn’t think that was a huge factor for most companies that split stocks.
I have yet to find any evidence to suggest there is a genuine improvement in a company’s performance because of a split. Have you?
Should I Buy TD Before Its 2-for-1 Stock Split?
The answer to this is simple: Would you buy it if it wasn’t splitting?
- Why more companies are doing the splits by John Heinzl in the Globe and Mail
- My Dividend Just Doubled for CU! Or Did It? Stock Splits and BMO InvestorLine
Do you think a share split in and of itself increases the value of a company? Or does it just increase the price of its shares? Please share your views with a comment.