There are many different factors investors may consider when it comes to buying stocks or rebalancing their portfolios. One of those is a company's stock price and how its performance changes over a certain period of time. Although looking at the historical or past price of a stock doesn't necessarily open a window into how it will do in the future, it is a good way for investors to understand the company's outlook in the coming years.
There may be some tricks investors need to keep in mind when it comes to the share price, especially if a company has undergone stock splits over its lifetime. In these cases, comparing historical stock prices to those of the present-day doesn't accurately reflect performance. This is why, as an investor, you must compare split-adjusted share prices. Read on to find out more about split-adjusted share prices and how they work.
- A stock split increases the number of outstanding shares and also affects the share price by a certain fraction.
- Companies may choose to do stock splits to keep their share price affordable or to give more shares to existing investors.
- In order to analyze a stock's real performance, adjust pre-split prices by dividing the old share prices by the number of shares awarded per single share.
- To find prior values when a company has performed multiple splits, multiply the number of shares split in each iteration to find the number to divide by.
- Stock splits do not create or destroy any equity value; any change in a company's total market cap during a stock split is due to normal market price fluctuations.
What Is a Split-Adjusted Share Price?
When a company issues a stock split, it increases the number of outstanding shares available. Doing so doesn't only increase the number of shares, it also affects the share price—hence the term split adjustment share price. When the price is adjusted because of a stock split, it is reduced by a certain fraction. So, a two-for-one stock split takes an existing share and splits it into two, adjusting the price by half. Similarly, a three-for-one stock split takes one share and splits it into three new shares. The price for this split is adjusted—or divided—by three.
Why Companies Split Stocks
Companies split shares for different reasons. They may do this to keep their stock price affordable so more investors can buy shares. The board of directors may decide that the share price has increased so much that it's too expensive, and split their stock in order to remain competitive with similar companies in their sector or industry. Another reason they may use this strategy is to increase the number of outstanding shares by giving existing shareholders a bigger stake in the company.
Before a company splits its stock, it may choose to increase the number of authorized shares, especially if the company is considering issuing the stock split in the form of a dividend. For example, both GameStop and Tesla brought forth proposals to increase their number of authorized shares with the intention of a future stock split.
The most common are two-for-one stock splits and or three-for-one stock splits.
Example of a Split-Adjusted Share Price
Let's illustrate the adjusted share price with a fictional company called TSJ Sports Conglomerate as an example. This sports management company has grown a great deal and undergone numerous stock splits. When the company first went public, its shares traded for a base price of $10. After several years, the company's share price appreciated to $50. That's the point at which management felt that a two-for-one share split was appropriate, thus reducing the cost of a single share to $25.
As time went on, the company's share price continued to rise and, in accordance with the management's policy, the stock was split each time it reached $50. In total, the company split its shares four times since going public. A single share of TSJ now trades at $25 just after its last stock split.
Because of all these splits, it's easy to see that the share price has appreciated much more than 2.5 times, from $10 to $25. Because TSJ has undergone four two-for-one splits, one original share in TSJ would actually be worth approximately $400 today.
Calculating the Split Today
If you bought and held one original share of TSJ until the present day, you would have 16 shares of TSJ:
- First split: 1 x 2 = 2
- Second split: 2 x 2 = 4
- Third split: 4 x 2 = 8
- Fourth split: 8 x 2 = 16
Figure 1 below shows how we reach the $400 value.
|Splits||No. of Shares||Share Price||Total Value|
So, even though one of TSJ's current shares is $25, one original share is worth $400 ($25 x 16), and therefore appreciated 40 times ($400 ÷ $10). This means TSJ stock is a quadruple tenbagger—a very elusive investment indeed. A tenbagger is an investment whose value appreciates ten times its original purchase price.
For discerning and analyzing the real performance of the stock, it is standard to adjust the old prices to reflect the splits. In other words, we have to find the present equivalent of the past prices. To adjust TSJ's original price of $10, we simply divide it by the stock split, or by two. After four times, we get the split-adjusted price.
After the first split, the original initial public offering (IPO) price of $10 is divided by two, giving a split-adjusted price of $5.
Adjusting After Each Split
After the fourth split, the original $10 price is equivalent to $0.625 today. So, if you were to look at a stock chart of TSJ that went back to its initial offering, the price for the first day of trading would be shown as $0.625, even though the stock never really traded at this price.
Figure 2 demonstrates how the original $10 price is adjusted after each split.
|Splits||No. of Shares||Adjusted Price||Total Value|
It's important to remember that a split actually creates no value. Notice how the column on the very right is simply the product of multiplying the number of shares by the split-adjusted price. The gain of 40 times we saw earlier in this article was the result of growth, not splits.
Are Stock Prices Split Adjusted?
Yes, stock prices are adjusted for stock splits. The adjustment is based on the multiple of the split. For example, in a 7-for-1 split, the number of shares will multiply by 7, but the share price will divide by 7.
Is a Stock Split Good for Investors?
A stock split is often seen as a positive sign that a company is doing well. A split is often done when the company's share price has substantially increased over time. The general notion behind a stock split is to make individual shares more affordable to retail investors, so there is potential for increased demand for a company's stock after a split.
How Do You Adjust for Multiple Stock Splits?
Multiple stock splits are adjusted for by combining the multiplying the split factor(s). For example, let's say a company performs a 2-for-1 split only to later perform a 7-for-1 split. The original share price and number of shares available will be impacted by 14; this is determined by multiplying the split amount from every round.
What Are the Disadvantages of a Stock Split?
There are some downsides to a stock split. As the share price will become more accessible to more investors, there is an increased risk that a company's stock will be more volatile after the split. The act of a stock split is also potentially expensive as the company must ensure compliance with listing exchange and legal requirements, notification to all shareholders, and administration of record-keeping.
There are also risks by intentionally striving to have a low individual stock price. Should the share price fall below $1, the company may face delisting warnings from public exchanges such as NASDAQ or the New York Stock Exchange.
Is It Better to Buy Stock Before or After a Stock Split?
Broadly speaking, there is an argument that a company's share price will increase as a result of a stock split. As the company's stock becomes more affordable, it is easier for investors to trade. This rise in demand may lead to a stock price increase after the split. A counterargument could be made due to the psychology of seeing the price drop; though a deliberate act of reducing the price with no bearing on the financial performance of a company, some investors may be less attracted to a smaller price (even if total market cap remains the same).
Investors should consult their financial advisor for direct guidance on what to invest in and when to invest funds. It's often advised to not try and time financial markets. If you believe in the growth prospects of a company, many advisors will recommend investing in the company and avoiding trying to make decisions based on short-term pricing fluctuations.