Best months to make gains in the stock market

Best months to make gains in the stock market

A visual guide to stock splits

Imagine a store window containing large chunks of cheese.

If the value of cheese increases over time, the price may exceed what the majority of people are willing to pay. This is a problem because the store wants to keep selling cheese, and people still want to eat it.

The obvious solution is to break the cheese into smaller pieces. This way, more people can again buy parts of it, and those who want more can buy more small parts.

The total volume of cheese is still the same amount, only the portion size has changed. As the above chart by StocksToTrade shows, the same concept applies to stock splits.

Like cheese wheels, stocks can be divided in a number of different ways. Some of the more common splits are 2 for 1, 3 for 1, and 3 for 2. Less common splits can also occur, such as when Apple increased its outstanding shares by 7 to 1 in 2014.

Why do companies split shares?

Of course, stocks are not cheese.

The real world of financial markets, driven by macro trends and animal spirits, is more complex than the items in the shop window.

If companies want their stock price to keep rising, why would they want to split it, effectively bringing the price down? Here are some specific reasons for this:

1. Liquidity
As our cheese example showed, stocks can sometimes see price hikes to the point where they are no longer available to a wide range of investors. A stock split (i.e. making an individual stock cheaper) is an effective way to increase the total number of investors who can buy shares.

2. Send a message
In many cases, the announcement of a stock split is a harbinger of the company’s prosperity. Nasdaq found that the companies that split their shares outperformed the market. This is likely due to investor excitement and the fact that companies often split their stocks as they approach periods of growth.

3. Reducing capital costs
Stocks with very high prices have wider spreads than similar stocks. When the spreads – the difference between bid and offer – are too large, they eat up the investor’s returns.

4. Meeting index criteria
There are specific instances in which a company may wish to adjust its share price to meet certain index requirements.

One such example is the Dow Jones Industrial Average (DJIA), a well known index of 30 stocks. The Dow is a price-weighted index, which means that the higher the price of a company’s stock, the more weight and influence it has within the index. Soon after Apple did a 7-to-1 stock split in 2014, dropping the stock price from about $650 to $90, the company was added to DJIA.

On the other hand, the company may decide to pursue a reverse stock split. This takes the current amount of shares that investors are holding and replaces them with fewer shares at a higher price. Regardless of the general stigma attached to a drop in the stock price, companies need to keep the price above a certain threshold or face the possibility of being delisted from the stock exchange.

A stock split does happen, but it’s not inevitable

Alphabet will become the latest high-profile company to make a stock split in early 2022. The company’s 20-for-1 stock split aims to make the share price more affordable for retail investors, bringing the price down from about $2,750 to $140 per share.

Conversely, Berkshire Hathaway has never been famous for its stock split. As a result, a single stake of BRK.A is worth more than $470,000. Berkshire Hathaway’s legendary founder, Warren Buffett, explains that a stock split would conflict with his buy-and-hold investment philosophy.

2022-05-30 18:42:32

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