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Why Companies Split Stock

Stock splits get many investors all excited, but in many ways they're really non-events. One reason companies split shares is so that the price will remain psychologically appealing. Reducing a stock's price makes some investors think (incorrectly) that it's a better value.

Sometimes, not splitting would mean that few people could afford even a single share. If, in its 80-odd-year history as a public company, Coca-Cola (NYSE: KO  ) had never once split its stock, one share would be priced at well more than $200,000 today. Not too many people could afford even a single share. In fact, Coke has split so many times in its history that if you had bought just one share when it went public in 1919, you'd have more than 4,600 shares today.

Some companies split their stock fairly frequently, while it's a rare event for others. It largely depends on how rapidly the stock price is rising. Warren Buffett's Berkshire Hathaway (NYSE: BRK.A  ) (NYSE: BRK.B  ) has never split its stock. Accordingly, an original share of Berkshire stock was trading for around $93,000 at the time of this writing. (Buffett did spin off a lower-priced class of shares at one point, though -- called Class B shares and sporting the ticker symbol BRK.B -- to help investors of more modest means buy in.)

With stocks, just as with any purchase, examine what you're getting for the price. Study the company and compare the stock price to other numbers, such as earnings or better yet, cash flow. A low price might be inviting, but a $200 stock can be a better bargain than a $20 stock -- and can be an even better buy than a $2 stock. Remember -- a $200 stock can become a $400 stock, while a $2 stock isn't so unlikely to fall to $0.02 per share. If your funds are limited, you can just buy fewer shares of the company.

It's always fun to suddenly own more shares, but splits are like getting four quarters for a dollar. They're not cause for celebration.

You can learn more about investing in stocks in our Investing Basics area. Also, check out our Mutual Fund area and zero in on our index fund information there. If you'd like to receive several promising investment ideas delivered via email each month, learn more about our investing newsletters.

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  • Report this Comment On May 11, 2013, at 7:19 PM, prginww wrote:

    This is definitely true about coke, but pretending companies like Coke never had a stock spit = people without the minimum of 200,000 dollars couldn't own a "small share" the company indirectly isn't really true (no pun intended). Haha!

    Pretending Coke for example never had a stock split and they were 200,000 a share. Nothing says someone can't split a share into partial shares, "Sharebuilder does this now".

    Even with that aside, there's nothing that says I couldn't create my own holding company, buy shares of coke, and sell my company for 2 bucks a share if I wanted too. Then people would indirectly own part of Coke too.

    The reason most companies don't want ridiculously high stock prices is for volume reasons, and also because it becomes harder to raise capital for your company given the fact that investors don't want to commit into investing an entire 200,000 (for example) into a company. Especially smaller companies and IPO's. You're risking way to many dollars for "your share". Investors want a "smaller share of the company" potentially risking less dollars into that company.

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