Stock Splits Affect Perceptions, Not Value

Shareholders of SBS took action in June to save the national media network from being dropped by the NASDAQ stock exchange.

With low prices putting the stock at risk of falling below the $1 minimum share price, investors approved a reverse stock split of 10-to-1, according to the website www.rbr.com, which tracks the industry. The move, which went into effect mid-July, combines every 10 shares of outstanding common stock into one, buoying share prices while reducing the number of outstanding shares.

Stock splits and reverse stock splits are a strategic tool used by companies to prevent their stocks from being delisted, as in the case of SBS, or to enhance the image of their stock. A reverse stock split by Citigroup Inc. raised their share price to $40 in May for the first time since 2007, according to the online Wall Street Journal. The move converted every 10 outstanding shares into one, and in the process boosted a single-digit share price that reflected the battering received by the bank during the financial crisis.

Reverse stock splits can signal that a company expects to be entering a rough patch, while stock splits are generally seen as a sign a company expects stock prices to continue to climb. Companies will also use stock splits to bring share prices back into a more affordable range. Rumors now speculate the Apple Inc. may split its stock in an effort to bring shares price down from highs around $400. By lowering price, splits can also make a high-priced equity easier to buy and sell, thus increasing liquidity.

Investors are not initially affected by stock splits, which do not change the underlying value of the investment. Dividends are also paid out proportionally over the new shares. Over time, splits can influence the performance of a stock in a variety of ways. Splits of high-priced stocks can increase demand for shares as investors begin to perceive a company as more affordable, and the higher demand can push up the value of the investment. The upward effect on prices tends to level off.

The most common split is a 2-1 split, which doubles the number of outstanding shares while halving the value of each share. A 3-1 share triples the number of outstanding shares, and companies will also split stocks along a 3-2 and other ratios.