Impact Of A Stock Split On A Financial Statement

1218 words - 5 pages

Stocks play a significant part in our economy. For many investors, stock splits seem to be too great of deal. Everyone loves a good deal. It is a Buy One Get One stock or more for free deal for the investors. Stocks can split into any ratios, but the most common ratio is 2-for-1, 3-for-1, and 3-for-2. Splits of 4-for-3, 5-for-2, and 5-for-4 have been offered to the investors in the past. Recently, Apple (AAPL) surprised content investors by declaring a massive 1-for-7 stock split and announcing a big second quarter earnings. Apple has split stocks four times since trading publicly. Apple's common stock split on a 2-for-1 basis on May 15, 1987, on June 21, 2000 and again on February 18, 2005 (Apple, 2014).

The stock split is simple. You have a $100 bill in your wallet, but you decide to carry five $20 bills instead because of the popularity of smaller $20 bill instead of a large $100 bill.
For transaction below, if you owned 10 million shares of XYZ Corporation at $10 per share initially, and the corporation offers a 2-1 stock split, upon the split you would own 20 shares worth $5 each. For the same concept, you would owe 30 million of $3.33 per share for a 3-for-1 split, and for a 3-for-2 split, you would owe 15 million of $6.66 per share.

Pre-Split Post-Split
2-for1
# of Shares 10M 20M
Share Price $10 $5
Market Cap $100M $100M

3-for-1
# of Shares 10M 30M
Share Price $10 $3.33
Market Cap $100M $100M

3-for-2
# of Shares 10M 15M
Share Price $10 $6.66
Market Cap $100M $100M

Why do companies issue splits if there is no increase or decrease to capitalization? What kind of financial impacts do the stock splits cause to the companies and investors?
First, the stock splits have greater psychological impacts to the investors than financial impact. When the price of a stock continuously increases, especially during a bull market, the investors may think that the price has gone too high to purchase. Small investors may also think that it is not affordable to purchase the stock. Splitting the stock will bring the share price down to a price that is more attractive to specific types of investors. For Apple, the 7-for-1 split will bring their share price from around $565 per share to approximately $80 per share. Apple will attract more investors at the $80 per share than the $565 per share. The impact by the price split to these investors is purely psychological. The actual value of stock does not change, but the lower stock price may impact on the way the stock is perceived and entice new investors to open up their wallets.
Second, many investors believe that splits are beneficial to their portfolios. They may think that the $5 per share, half-price stock after the split, may increase to its original price of $10. This is not the case for the stock split. Although the numbers of shares may have tripled or quadrupled, now that each stock represents half of the equity in a corporation that it did before the...

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