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A stock split is when a company decides to divide its shares of common stock into two or more pieces. There are different reasons companies might choose to do a stock split, but most traders will want to buy stocks before a split happens and sell them afterwards.
Let’s look at some of the pros and cons of stocks trading before or after they split.
What is a stock split?
A stock split is when a company divides its existing shares into multiple new shares to boost liquidity and make the shares more affordable. For example, if you own one share of ABC Company that’s trading at $100 before a 2-for-1 stock split, you’ll own two shares worth $50 each after the split.
Stock splits are usually well received by investors because they perceive the move as a sign of confidence by management in the company’s future performance. As such, stocks often experience a short-term price increase following a stock split announcement.
The benefits of buying stocks before a split
The two main types of stock splits are a regular split and a reverse split.
In a regular split, the number of shares outstanding is increased, while in a reverse split, the number of shares outstanding is reduced. For example, if a company with 100 million outstanding shares declared a 2-for-1 stock split, the post-split share count would be 200 million. There are benefits to both types of splits; a regular stock split is generally seen as more favourable from an investor’s perspective.
One advantage of buying stocks before a split is that it allows investors to acquire more shares for their investment dollar. If an investor buys 100 shares of XY Company at $10 per share before a 2-for-1 stock split takes, they will own 200 shares after the split, worth $20 per share. It effectively doubles the investor’s position without investing any additional money.
Another benefit of buying stocks before a split is that it can signal to other investors that the company is doing well and is confident in its prospects. It can lead to an influx of new buyers, which could help drive the stock price higher.
The benefits of buying stocks after a split
There are several benefits to buying stocks after a split. First of all, it can make the shares more affordable for individual investors. Secondly, it can increase liquidity and make it easier for investors to buy and sell shares.
Thirdly and finally, it can signal confidence on the company’s part, attracting more investor interest and leading to gains in the stock price. For these reasons, savvy investors often watch stocks that have recently undergone a split.
So, when should you buy stock – before or after a split?
While a stock split does not directly impact the value of a shareholder’s investment, it can indirectly affect the price. Generally speaking, the stock price will go up in the days leading up to the split as investors anticipate increasing the number of shares. After the split, the price will usually adjust downward to reflect the increased supply.
As a result, timing is crucial for buying stocks that have announced a split. For investors looking to purchase shares, it is usually best to do so after the stock has adjusted to its new price following the split.
How to know if a stock split is happening soon
If you’re wondering whether a stock split is about to occur, here are some things to look for:
- Suppose there is an increase in the number of shareholders. It can signify that management is considering a stock split to make shares more widely available.
- Suppose there is a change in the company’s dividend policy. A dividend increase can sometimes presage a stock split, as management may want to make shares more attractive to investors.
- Suppose there are rumours or news reports ab out a potential stock split. Although this isn’t always an accurate indicator, it’s worth keeping an eye on what’s being said about the company in the investment community.