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.)

  1. What is a stock split? Why do stocks split?

    All publicly-traded companies have a set number of shares that are outstanding on the stock market. A stock split is a decision ... Read Full Answer >>
  2. How do I place an order to buy or sell shares?

    It is easy to get started buying and selling stocks, especially with the advancements in online trading since the turn of ... Read Full Answer >>
  3. Is there a difference between financial spread betting and arbitrage?

    Financial spread betting is a type of speculation that involves a highly leveraged derivative product, whereas arbitrage ... Read Full Answer >>
  4. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  5. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  6. What is the difference between passive and active asset management?

    Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and ... Read Full Answer >>
Related Articles
  1. Options & Futures

    Pick 401(k) Assets Like A Pro

    Professionals choose the options available to you in your plan, making your decisions easier.
  2. Investing Basics

    5 Common Mistakes New Investors Make

    When it’s time to start investing, watch out for these five common beginner’s mistakes.
  3. Investing Basics

    5 Investing Statements That Make You Sound Stupid

    If you want to talk investments without being mocked, avoid these five statements.
  4. Stock Analysis

    The Biggest Risks of Investing in Berkshire Hathaway Stock

    Learn about the risks of investing in Berkshire Hathaway. Understand how issues of succession, credit downgrade risk and increased regulation could hurt it.
  5. Mutual Funds & ETFs

    How to Profit From Market Volatility Using ETFs

    Volatility funds offer exposure to high greed and fear levels while avoiding predictions on price direction.
  6. Investing Basics

    The Top Five Public Railroad Stocks in the U.S.

    We offer a breakdown of the seven Class I railroads in North America based on their annual revenues.
  7. Investing

    How to Effectively Monitor Your Stock Holdings

    Investors should concentrate on the business, not the stock price.
  8. Professionals

    Will Interest Rates Rise at the Next Fed Meeting?

    Everyone wants to know what the Federal Reserve will do next, but the Fed doesn't even know what it's next move will be.
  9. Economics

    Tech Startups Can Save Detroit, Here is Why

    Rising from the ashes in the once proud auto-manufacturing City of Detroit is a rapidly emerging tech startup scene that could prove to be its salvation.
  10. Investing Basics

    Calculating Capital Gains Yield

    Capital gains yield refers to a security’s appreciation or depreciation during the time it’s held.
  1. Hunting Elephants

    The practice of targeting large companies or customers.
  2. Warren Buffett

    Known as "the Oracle of Omaha", Buffett is Chairman of Berkshire ...
  3. Fractal Markets Hypothesis (FMH)

    An alternative investment theory to Efficient Market Hypothesis ...
  4. Bid Wanted

    An announcement by an investor who holds a security that he or ...
  5. Spot Rate

    The price that is quoted for immediate settlement on a commodity, ...
  6. Hindsight Bias

    A psychological phenomenon in which past events seem to be more ...

You May Also Like

Hot Definitions
  1. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  2. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  3. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  4. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
  5. Cost Accounting

    A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step ...
  6. Capitalized Cost

    An expense that is added to the cost basis of a fixed asset on a company's balance sheet. Capitalized Costs are incurred ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!