However, David Goldreich, a finance professor at the University of Toronto’s Rotman School of Management, says stock splits are sometimes seen by investors as a positive signal. “When the manager does a split, it is reasonable to interpret it as management is confident that the future is looking good,” he said. He said if executives at a company are expecting a rough patch that could hurt the price of its shares, it’s unlikely they will want to split them, but if they are optimistic about future growth, a split might be more likely.
Goldreich said companies sometimes split their shares to keep their share price within what is seen as a “normal range,” which he puts at between $50 and $100 per share.
Stock splits make shares cheaper, not more valuable
Stock splits don’t create any shareholder value, they only divide the ownership of a company into smaller pieces. If you own 100 shares in a company with a share price of $10 each and it splits it shares two-for-one, you double the number of shares you own, not the value of your holdings. Your investment in dollar terms remains the same. Instead of owning 100 shares with a price of $10 per share worth a total of $1,000, you now own 200 shares at a price of $5 per share—the total worth is still $1,000.
When grocery retailer Loblaw Cos. Ltd. split its stock last month on a four-for-one basis, it said it was doing it to ensure its shares remained accessible to retail investors and its employees that participate in its employee share ownership plan, and to improve liquidity. Loblaw shares were trading for more than $200 a piece before the split, making it a pricey purchase for small individual investors looking to buy a position of 100 shares in the company.
Will Gornall, an associate professor at UBC’s Sauder School of Business, uses the analogy of a pizza when explaining how a stock split works. If you have three pieces of pizza and they are split two-for-one, you end up with six pieces of pizza, but the total amount of pizza you have is the same, the pieces are just smaller. “It’s not really changing the fundamentals of the company in any way, just like if you slice the pizza differently, you’re not creating more pizza,” Gornall said. “The amount of pizza hasn’t changed, but now you have more slices.”
It’s the same for stocks.
Chipmaker Nvidia, which split its stock 10-for-one last year, said it was doing it to make its stock more accessible to employees and investors. Shares in Nvidia were trading for about US$1,200 each before the split last year. The move brought the share price down to about US$120 per share immediately after the split, but the overall shareholder value of the company was unchanged.
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How stock splits affect dividends and taxes
Goldreich added that when dividend-paying companies split their shares, they generally adjust their dividend to match the split to keep things constant. But if a company keeps the same payment per share after the split, it effectively increases the dividends paid to shareholders. If that happens in a two-for-one share split, “essentially what they’re doing is they’re doubling the dividends,” Goldreich said.
There are also adjustments that have to be made when it comes to taxes when you sell shares that have been split since you bought them.
For example, if you bought 100 shares for $10 each and they split two-for-one, your cost for the shares when calculating the capital gain when you sell them needs to be adjusted. While you paid $10 per share when you bought them, the adjusted cost after the two-for-one split becomes $5 per share because you now hold twice the number of shares. That means if you sold the shares after the split for $10 each, you would realize a $5 gain per share.
Goldreich said the key thing to remember is that there is no free money with stock splits. While you may have more shares in a company, that doesn’t mean your investment is worth any more. “You can’t magically become richer,” he said.
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The Canadian Press
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