Do stock splits create value? Consider the analogy of having a lump of gold (set volume,...

Do stock splits create value? Consider the analogy of having a lump of gold (set volume, the form has no value, such as a minted, limited edition coin may have). Would you consider going to your shop and sawing your lump of gold into 2 pieces (a “gold split”), so that you would be wealthier with 2 pieces of gold? What are some of the “transaction costs” of executing this “gold split”? Consider another analogy of going out to pizza with your friends. If on a particular night your group feels extra hungry, would it make sense to say to the pizza shop: “Hey, you know that pizza we usually order and you serve cut in 6 pieces? Would you split those pieces & cut it into 12 pieces tonight, since we are all extra hungry and want more “value”?

Expert Solution

Answer:-

Theoretically stock splits does not create value to the investors. Stock split does not change the fundamentals of the company and moreover there is no change in the earnings and equity base capital.

The stock split makes the stock cheaper. For example suppose the stock is valued at $ 1000, and the company announces 5:1 split ratio. The company stock will trade at $ 200 post the split. But the stock post the split valued at $ 200 becomes more attractive to the small investors and the trading activity increases in the stock.

The stock split in a way signals that the company wants more investor participation. Continuing with the example that the company's stock is $ 1000 and has 1 million shares outstanding. The company stock post split of 5:1 has a price of $ 200 and has 5 million shares outstanding but the total equity base capital remains at $ 1000 million and does not change. So with more number of shares available at lower price may increase the small investor participation. The increase in value of stock price completely depends on the fundamentals such as earnings and has nothing to do with stock splits.

jeff jeffy answered 7 months ago

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