In the USA the stock price of most major companies is in the range of $10 to $70. For example, 80 percent of the stocks in the S&P500 lie in this range. The ranges for the smaller cap stocks tend to be lower. Other countries also have their accepted ranges.
It is not an accident that the prices of most stocks lie in such ranges. Rather it is because of deliberate action of management through stock splits. A stock split is when management decides to offer a set number of shares for each share that is outstanding. For example, with a 2-for-1 stock split, each shareholder receives an additional share for each share held. This has the effect of reducing the price by 50 percent. A share price before the split of $80 would reduce to $40 after the split. In this way, the market cap of the company stays the same.
Splits with other ratios such as 3-for-1 or even 3-for-2 take place. It is also possible to have a reverse stock split: a 1-for-5 reverse stock split would mean that for every five shares you own you will now have a single share.
After a split, “per share” financial data associated with the company will change to reflect the increased number of shares. For example, continuing with the 2-for-1 example, historical data such as earnings per share and sales per share will be halved. However, ratios such as return on equity will stay the same.
Clearly a share split does not add any value to the shareholder or to the company. So why do management implement them? The reasons are based on the belief that if the stock is more actively traded, then the price will be pushed upwards. After a stock split, it is argued that there will be more daily transactions firstly because the price is in the range that most investors are comfortable with as described above. They may, for example, see a stock trading at $70 as expensive whereas if it was trading at $35 it would be seen as more reasonable and therefore they would be more likely to buy it.
Secondly, there may be more transactions because there are more shares on the market, hence more liquidity and so a smaller bid-ask spread.
Some people argue that buying stock in a company just before a split is a profitable strategy since it is a positive signal that the business is growing strongly and that this growth has not been properly recognized by the market.
However, in the end a stock split has no effect on the worth of the company or on the value of any holding in the company. If you have two $50 bills or a single $100 bill, then you have the same buying power.
