Going Bananas Over Splits

We've been sorting through questions in advance of our upcoming "Ask TheStreet" column, and one recurring query we've noticed is whether a stock split is -- as Martha Stewart would say -- a good thing.

In our reply, we ask a question of our own: Would you rather have a single $100 bill, or a pair of $50 bills?

No, it's not a trick question. It's the same thing.

Well, that same logic applies when it comes to stock splits.

When a company's stock price gets very high, some investors may shy away from purchasing it. In an effort to lure investors with a lower price tag, companies often split their stock in two or more equal parts. For example, if XYZ Co.'s stock climbs to $120, the company may announce a 3-for-1 stock split, meaning shareholders would get three $40 shares for every $120 share they hold. The underlying value remains the same.

In essence, the "six of one, half dozen of the other" model holds true. But investor sentiment often makes it seem different. Some investors, for example, may like to purchase shares in 50-share or 100-share lots, and a big price tag for one stock may keep them away. A stock split gives these smaller investors a psychological boost to buy the stock.

Consider the case of star investor Warren Buffett's company, Berkshire Hathaway(BRK.A Quote - Cramer on BRK.A - Stock Picks). Buffett has never split his stock, which is why Berkshire's shares trade at close to $90,000 each. If the so-called "Oracle of Omaha" ever decided to split his stock, it would increase the opportunity for millions of smaller investors to finally buy a piece of Berkshire. The ensuing rush to buy the stock could very well cause a temporary spike in the price, but remember, it wouldn't change the value of the company.

« Previous Page

1 2

Next Page »