Phil, Happy 4th of July! I attended the get motivated event in Hartford ct a month or so ago thought it was great. I ordered your book on line. Payback Time. I just finished chapter 4. I will get to the point; a friend of mine works for Coke and was telling me that they were going to have a stock split. Again I am only half way thru your book but something tells me that this would be a no brainer to buy their stock after it splits to start stockpiling. I was watching a financial news cast on line and they were saying to buy now before it splits. I worked for Home Depot for years back in the late 90's and went thru a handful of splits so I understand how they work but if you are stockpiling would'nt you want to buy after the split, or does it really matter on a stock split because once it splits you have the same amount of shares whether you bought before or after the split. I only have a couple of thousand to invest but don't want to miss an opportunity, I am a slow reader sad to say. By the time I finish your book the opportunity may have already passed. Looking for your professional opinion; do I buy before the split or after? Thank you for your time! Ron
So let's talk stock splits.
Stock splits are a magic act. There isn't a cent more value in the business post-split than pre-split but often the stock price goes up post split. Magic.
Think about it a second and you'll see the rabbit was in the hat the whole time: All that happens in the split is that the number of shares of Coke stock doubled and the price of each share gets chopped in half. That's all. The pizza had 10 slices and the magician took a pizza cutter and chopped it into 10 more pieces. There were ten pieces. There are now 20 pieces, but it doesn't take a lot of thought to realize that the Pizza didn't get any bigger.
We can get caught up in the magic act of ‘stock price per share’ if we have not yet learned to think of stock as a piece of a business. Let's look at it that way and you'll see what I mean. Coke is priced at about $80 a share let's say. I own 20 shares. They split the stock and now I own 40 shares. But what happened to the price? It is now $40 per share. Before the split I had $1,600 of Coke stock. After the split I still have $1,600 of Coke stock. I didn't get any richer. I just have twice shares at half the price. Why is that? Because the value of Coke as a company has nothing, zero, to do with the number of shares. Coke could have 1 billion shares or 1 milllion shares or 100 shares and its value as a business would be exactly the same in each case.
Remember, most companies start out with one owner who may own the entire thing ... essentially 1 share. If the company never goes public and never sells any stock, it could be worth $100 billion and still only have 1 share. When companies need money, they sell stock to the public. The value of the business doesn't change but the number of shares changes and the value per share changes. That's all.
Yet people get excited about a stock split. Why? Because of the magic act. Coke used to be at $80 so people who think in magic terms – in terms of price only – think that it was $80 so its going to go to $80 again starting now at $40 as if nothing other than price will take it back to where it was. That's the act. There's no more reason for Coke to go from $80 to $160 than from $40 to $80. That would be the exact same thing and it will eventually only happen based on what happens to the business. It will go there based on its sales and earnings and its increasing future value but the number of shares and the price per share are pretty much meaningless.... Except.
Except for a couple of things that encourage the magic. Coke is part of an index ... Index stocks are requested to trade in a range so that they can be more easily balanced out by the index buyers. Thus most if not all index stocks split to stay in that range as they grow more valuable. Thus one reason for the split is to stay in that range. There may be a tad of index rebalancing going on after the split. A tad. A smidgeon. But enough to nudge the price a bit for a bit.
And optionable stocks have an advantage if they are in a certain price per share range because they are sold as options in 100 share contracts. 100 shares of Coke at $80 costs $8,000. 100 shares of Coke at $40 is only $4000. This helps more people ‘afford’ Coke options?
That's it. That's all there is to the stock split magic. Indexes and options. The rest of it is pure perception and sleight of hand by brokers who say things to their clients like, "Coke is splitting and after it goes to $40 its going to jump up toward $80." Or, “Coke is less expensive at $40 than it was at $80.” Nonsense. But it plays to the emotions.
Rule #1 investors don't play that emotional game. We stay rational and buy value and value is what we get. Price is just what we are willing to pay. Don't ever get confused about the two. Stock price doesn't mean anything unless you know the value.
By the way, Coke is WAY up there in the red zone so watch out if you are thinking of playing the split game. Eventually the stock gets priced rationally.
Now go play.