A:

The answer can be found in stock splits - or rather, a lack thereof. The vast majority of public companies opt to use stock splits, increasing the number of shares outstanding by a certain factor (e.g. by a factor of two in a 2-1 split) and decreasing their share price by the same factor.

By doing so, a company can keep the trading price of its shares in a reasonable price range. Most publicly-traded companies keep their share prices below $100 largely to maintain a reasonable share price range which ensures the liquidity of the stock is not eroded as the company increases in value. In simple terms, this means that if a company splits its shares every time it breaches the $100 mark, investors will be able to invest in the company in relatively small chunks, which can be advantageous when it comes to building a balanced equity portfolio.

A tenacious growth stock since its inception, Microsoft (MSFT) provides a good example of stock splitting used to maintain a reasonable trading range. Since 1987, MSFT has split nine times. In 1986, it was trading at about $30 a share - about the same price at which it traded in 2005. However, every time the stock split, its price was lowered and its number of shares doubled. Thus, to compare the actual price of 2005 to 1987, we need to use a split-adjusted price which removes the effects of the nine splits. When we do this, we find Microsoft's 1987 split-adjusted price is only about $0.08 per share, while the 2005 range is of course about $30. This means that Microsoft shares today are worth about 375 times what they were worth in 1987. If they had never split, Microsoft's shares would be trading in a range of over $10,000 per share!

Of course, since Microsoft has split so many times, this is not the case. But there are a few companies that, for one reason or another, choose not to use stock splits. Warren Buffett's holding company, Berkshire Hathaway, is the most prominent example. Since Buffett came to control the firm, its stock has never split, even while the share values grew substantially in each decade since the 1960s. Unlike Microsoft, Berkshire Hathaway's stock was already trading at more than $8,000 a share by the late '80s. In 2005, after roughly 40 years of split-free growth, Berkshire Hathaway Class A (BRK.A) shares trade for more than $80,000.

Whether a company is trading at $80,000 or $8, we can get a sense of its expensiveness by comparing its price to its earning potential. At the time of writing (Aug 2005), BRK.A has a 12-month trailing P/E ratio of a little under 20, while MSFT has a trailing P/E of roughly 24. By this measure, BRK.A shares are actually slightly less expensive than MSFT shares, even though they trade in much larger denominations.

(To learn more about equity valuations, read our Ratio Analysis Tutorial. To learn more about stock splits, see Understanding Stock Splits.)

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