For example, assume that XYZ Corp. has 20 million shares outstanding and the shares are trading at $100, which would give it a $2 billion market capitalization. The company’s board of directors decides to split the stock 2-for-1. Right after the split takes effect, the number of shares outstanding would double to 40 million, while the share price would be $50, leaving the market cap unchanged at $2 billion.
Why do companies go through the hassle and expense of a stock split? For a couple of very good reasons:
First, a split is usually undertaken when the stock price is quite high, making it pricey for investors to acquire a standard board lot of 100 shares. If XYZ Corp.’s shares were worth $100 each, an investor would need to purchase $10,000 to own 100 shares. If each share was worth $50, the investor would only need to pay $5,000 to own 100 shares.
Second, the higher number of shares outstanding can result in greater liquidity for the stock, which facilitates trading and may narrow the bid-ask spread.
While a split in theory should have no effect on a stock’s price, it often results in renewed investor interest, which can have a positive impact on the stock price. While this effect can be temporary, the fact remains that stock splits by blue chip companies are a great way for the average investor to accumulate an increasing number of shares in these companies. Many of the best companies routinely exceed the price level at which they had previously split their stock, causing them to undergo a stock split yet again. Wal-Mart, for instance, has split its shares as many as 11 times on a 2-for-1 basis from the time it went public in October 1970 to March 1999. An investor who had 100 shares at Wal-Mart’s IPO would have seen that little stake grow to 204,800 shares over the next 30 years.