If a company has undergone stock splits over its lifetime, comparing historical stock prices to those of the present day would not accurately reflect performance. For this reason, we must compare split-adjusted share prices.
The necessity of this adjusted price is best illustrated with an example. We'll use a fictional company, the TSJ Sports Conglomerate. Over the decades, this sports management company has grown a great deal and undergone numerous stock splits. When the company first went public, its shares traded for $10. After some years, the company's share price appreciated to $50, and at that point the management felt that a 2-for-1 share split was appropriate, thus reducing the cost of a single share to $25. As time went on, the company continued to see a rising share price 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. Today, just after its last split, a single share of TSJ is trading at $25.
Because of all these splits, it is easy to see that the share price has appreciated much more than 2.5 times, from $10 to $25. In actuality, because TSJ has undergone four 2-for-1 splits, one original share in TSJ would be worth approximately $400 today!
|Splits||No. of Shares||Share Price||Total Value|
Figure 1 demonstrates how we reach the $400 value. If you bought and held one original share of TSJ until the present day, you would have 16 shares of TSJ (first split: 1x2=2, second split: 2x2=4, third split: 4x2=8, fourth split: 8x2=16). So, even though one of TSJ's current shares is $25, one original share is worth $400 ($25*16), and therefore appreciated 40 times ($400/$10). The TSJ is a quadruple tenbagger—a very elusive investment indeed.
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 ($10), we simply divide it by the stock split (2). After four times, we get the split-adjusted price.
After the first split, the original initial public offering price of $10 would be divided by two, giving a split-adjusted price of $5.
|Splits||No. of Shares||Adjusted Price||Total Value|
Figure 2 demonstrates how the original $10 price is adjusted after each split—so, after the fourth split, the original $10 price is equivalent to $0.625 today. 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.
It's important to remember that a split 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. (See also: Understanding Stock Splits and What Is a Stock Split?)