Question

Q#1.  According to the Wall Street Journal (WSJ), Apple, Inc. (AAPL) announced in 2013 a 7-for-1 stock split. Similarly, many other publicly traded companies have announced stocks splits. Most stock holders as well as some analysts and traders believe that a stock split would definitely benefit current shareholders and raise the firm’s overall market value. You read in chapter 14 that, in theory, a 7:1 split would increase the number of outstanding shares seven fold and cut down the post-split stock price to 1/7 of pre-split price, thus leaving Apple's shareholders' wealth unchanged. This theory asserts that stock prices should increase only when a firm generates more earnings (cash flows) which will raise earnings per share. But stock splits do not generate any additional earnings (cash flows) for the firm. So you are puzzled why some shareholders, traders, and analysts adamantly believe that stock splits benefit shareholders. Please explain whether or not stock splits in general would benefit a firm's current shareholders with at least a 5-year investment (holding) horizon. You would want to use your understanding of chapter 14 stock split material, especially the signaling aspects of stock splits, optimal stock price range theory, and past empirical evidence in your explanation. Limit your answers to no more than ten (10) sentences.

Answer 1

Stock splits simply lower the face value of the shares outstanding ,leaving the total value of shares outstanding, untouched.Naturally the no.of shares outstanding go up.

ie. Each share of stock is sub-divided into such no.of portions ,as decided by the management.

Thus stock splits only go to increase costs such as those needed for the administrative work & issuing new share certificates to the existing shareholders ,in place of the old one.

Optimal Trading Range theory--Company management resorts to stock splits when the share prices reach a high---splitting ,so as to make it affordable to potential investors --ie. To make the share easily tradeable in the market , by realigning prices.Thsi theory supports that the trading volume is bound to be affected by decreasing the per share price.

This is also done in expectation of increased earnings in future ----

But here, the existing shareholders will stand to lose on EPS , on account of new entrant-shareholders amongst whom the total earnings will be divided.

Signalling theory--- according to which managers proceed with stock splits only to emenate positive vibes across the investing public , about the financial health of the company.

The existing shareholders should sense that, if everything is well with the company, then why this re-alignment on such a sensitive area like stock price ?

Also, in stock-splits there is the possibility of diffused ownership & dilution in control--as investors become holders of lesser-valued shares. Thus,here also the shareholder dose not benefit

The whole exercise does not generate any additional cash flow at all ,leave alone to equity. Only outflow are certain as dealt above(issuing & administrative costs).----which only go to decrease income to the current shareholders.

Thus stock-splits may not be to the advantage of the existing shareholders--except for those who want to sell their shares--as marketaility & liquidity do increase multi-fold after the split.