Stock splits

When companies decide to raise capital they can do so in a few ways, apart from borrowing from a bank the main way is by issuing securities in the form of Equities (shares) to the general public. Shares represent proportional ownership of the company and a claim to future cash flows in the form of dividends, the value of the share is based partly on the amount of dividend paid. and partly on the future prospects of growth for the company.

When a share becomes highly priced due to investors wanting more of the company, such as happened with CSL breaching $100, there is sometimes a lack of liquidity, the most common solution to this is a share split, this refers to a corporate action that increases the number of shares in the company. The price of the shares are adjusted such that the before and after market capitalisation of the company remains the same and dilution does not occur.

Take CSL for example, shares were priced at $100 per share and the market capitalisation was $18 billion. The company yesterday confirmed that it will split its stock 3-for-1. Each shareholder now holds 3 times as many shares (CSLDA), with the price of each share adjusted to $33. The market capitalisation remains the same as before the split. Because a split does not increase the share capital, it cannot be taken as a gesture of confidence as a bonus issue can, however the liquidity increases as there are more buyers and sellers for 3 shares at $33 than there are for one share at $100.

Some recent examples of Share splits are Toll Holdings TOL (above) and Resmed RMD (below), as you can see the (adjusted) stock price has continued to increase after the split.

It is claimed that stock splits cause these higher % stock prices increases - although some would argue that as stock splits usually occur after a large run up in share price the momentum investing theory states such a trend would continue regardless of the stock split. It may also be a self-fulfilling prophecy; if investors believe that a stock split will result in an increased share price and therefore purchase the stock then the share price will tend to increase. Another positive is the confidence message in the future prospects of the company that the management of a company is conveying by initiating a stock split.

History would probably point you to the conclusion that with a split - you have to be in it to win it!