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 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. But there can 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, and to give more shares to existing investors.
- In order to analyze a stock's real performance, adjust the old prices to reflect the splits, find the present equivalent of the past prices.
- Splits actually create no value.
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.
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
Figures 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.