Should You Buy a Stock Before or After a Split?
Learn whether it's better to buy stocks before or after a split. Understand the pros and cons, and why insider trading is a no-go. Make informed investment decisions.
by S Samayanka
Updated May 27, 2024
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Stock Split
A stock split happens when a company's board of directors decides to increase the number of shares available. They do this by dividing each existing share into more shares, which makes the stock price lower.
However, this does not alter the overall value of the company. It's important to remember that a stock split itself doesn't create any new value for the company. The total value of all the shares remains the same after the split.
So, if you owned 10 shares of a company worth $20 each before the split (total value of $200), you would own 20 shares worth $10 each after the split (also with a total value of $200).
Should You Buy a Stock Before or After a Split?
Purchasing stocks prior to a split may appear advantageous since the price typically increases upon the announcement of the split. This has the potential to result in increased profits for investors.
It is important to keep in mind that engaging in trading based on non-public information is illegal and is known as insider trading. In conclusion, even though it may appear advantageous to purchase before a split, it is crucial to follow the regulations and refrain from trading using confidential information.
What are the Causes of Stock Split?
Making Shares More Affordable:
At times, the cost of a stock becomes too expensive for ordinary individuals to afford.
Splitting the stock reduces the cost of each individual share, increasing its affordability to a wider range of investors.
The company's valuation remains constant, but a discounted price could potentially lure in fresh investors.
Making Shareholders Feel Good:
When a stock splits, existing shareholders suddenly have more shares.
This makes them feel like they have more to trade if the price goes up.
Increasing Trading Activity:
A lower stock price can attract more people to buy and sell the stock.
This makes trading easier and faster, which is good for the company.
Challenges in Financial Theory:
According to financial theory, stock splits are typically seen as having little effect.
However, companies continue to carry out these activities because they have the potential to influence people's behaviour.
This difference between theory and practice is studied in a field called behavioral finance.
Advantages and Disadvantages of Stock Split
|
Basis |
Pros |
Cons |
|
Lower share price |
It makes it easier for regular people to buy shares. |
This may give the false impression that the company is doing better. |
|
Increased liquidity |
More shares are available for buying and selling, making trading easier. |
Stock prices may swing more in the short term, causing uncertainty. |
|
Boosts investor sentiment and confidence |
Investors may feel more positive about the company's future. |
It doesn't change the company's real value or financial situation. |
|
Signals management's confidence |
It suggests that company leaders are optimistic about future growth. |
Dilutes the value of existing shares, potentially upsetting shareholders. |
|
Makes employee stock options |
Employees feel like their stock options are more valuable. |
Can reduce the earnings per share, making each share less valuable for existing shareholders. |
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Should you Buy a Stock Before or After a Split - FAQs
1. What is a stock split?
A stock split is when a company increases the number of shares available by dividing each existing share into more shares, lowering the stock price.
2. Should I buy stocks before or after a split?
It might seem good to buy before a split, but it's important to follow the law and not trade based on non-public information.
3. Why do companies do stock splits?
They do it to make shares more affordable, make shareholders feel good, increase trading activity, and sometimes to challenge financial theories.
4. Do stock splits change the value of the company?
No, stock splits don't change the overall value of the company. The total value of all shares remains the same before and after the split.
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