What's the Point of a Split-Adjusted Share Price?
So, if the value
of the stock doesn't change, what motivates a company to split its
stock? Good question. There are several reasons companies consider
carrying out this corporate action.
The first reason is
psychology. As the price of a stock gets higher and higher, some
investors may feel the price is too high for them to buy, or small
investors may feel it is unaffordable. Splitting the stock brings the
share price down to a more "attractive" level. The effect here is purely
psychological. The actual value of the stock doesn't change one bit,
but the lower stock price may affect the way the stock is perceived and
therefore entice new investors. Splitting the stock also gives existing
shareholders the feeling that they suddenly have more shares than they
did before, and of course, if the prices rises, they have more stock to
trade.
Another reason, and arguably a more logical one, for splitting a stock is to increase a stock's liquidity, which increases with the stock's number of outstanding shares. You see, when stocks get into the hundreds of dollars per share, very large bid/ask spreads can result.
Let's use an example:
The first reason is
psychology. As the price of a stock gets higher and higher, some
investors may feel the price is too high for them to buy, or small
investors may feel it is unaffordable. Splitting the stock brings the
share price down to a more "attractive" level. The effect here is purely
psychological. The actual value of the stock doesn't change one bit,
but the lower stock price may affect the way the stock is perceived and
therefore entice new investors. Splitting the stock also gives existing
shareholders the feeling that they suddenly have more shares than they
did before, and of course, if the prices rises, they have more stock to
trade.Another reason, and arguably a more logical one, for splitting a stock is to increase a stock's liquidity, which increases with the stock's number of outstanding shares. You see, when stocks get into the hundreds of dollars per share, very large bid/ask spreads can result.
Over the years, Stryker (NYSE listing) has undergone multiple stock splits. If you compare the historical price of Stryker stock to those values of the present day stock this would not accurately reflect performance. For this reason, one must compare the "split-adjusted" share price.
Hypothetically,
when Stryker went public the cash price for Stryker stock was $10,
after four years the share price appreciated to $50, then Stryker's
management decided that a 2 for 1 share split was appropriate, reducing
the share price to $25. As years went by, Strykers stock rose to $50
per share and according to Stryker's policy the stock was split each
time the stock reach $50. Let's say that the company split its shares
four times since going public.
The share price
has then appreciated much more than 2.5 times from $10 to $25 dollars.
In actuality if the stock had undergone four 2 for 1 splits, therefore,
one original share would be worth $400. So if you bought one original
share and held it you would have 16 shares. So even though the current
share price is $25, one original share is worth $400 per share, and
therefore appreciated 40 times. This is called a "tenbagger" an elusive
investment that many investors look for.
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