Split Opinion on Stock Splits

In the Net space, investors love stock splits. It seems to be somehow a
guaranteed sign of more stock gains.

Yet, while splits have been good for many Net stock investors, this does
not prove that stock splits are a good sign.

Actually, in theory, a stock split is a neutral event. After all, a
company is merely increasing the number of shares outstanding —
nothing more.

Then again, there are some twists to the theory:

  1. Affordability: A stock split lowers the price of the stock. Since
    Net stocks tend to have a high proportion of individual investors, a low
    stock appears more affordable; that is, investors will be able to buy more
    shares. Thus, a stock split can help increase the demand for the stock.

  2. Bigger Float: As a company splits its stock, there are more shares
    available for investors to buy. This makes the stock more alluring to
    institutions. Why? Because a typical institutional stock position is
    valued in the millions, so they need to purchase big blocks of stock —
    without making a big impact on the stock price.

  3. Publicity: In most cases, a company will announce a stock split
    and it will get some press and cause excitement.

  4. Easier to Double: There’s a perception that it is easier for a
    stock to double if it has a small stock price. Then again, this has not
    been the case with Commerce One (CMRC)
    and Qualcomm (QCOM)
    .

  5. Signaling Theory: This theory says that a stock split is an
    indication that management is confident in the future of the company and is
    willing to split the stock as a result.

I think a more telling split is the so-called reverse split. This
reduces the number of outstanding shares, which in turn increases the stock
price.

This is usually done by companies that have had serious setbacks
and do not want the embarrassment of a low stock price. Unfortunately, a
reverse split typically does not reverse the problems of a company. In
fact, it is a sign that there is probably more trouble ahead.

Of course, reverse splits have been rare for Net stocks. But there may be
an equivalent; that is, when a Net stock splits its stock when it is
selling for a relatively low price. This was the case with
theglobe.com (TGLO)
, which split its stock when it was selling below $50 per share. Now
the stock is at $11.

Thus, when looking at stock splits, first see if the stock price is high,
say, over $100 per share. Then, make sure that the company is growing
strongly and will likely do so. The stock split will then be an element in
the decision to buy; but it should not be the only element.


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