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Don't Go Bananas for Stock Splits

There's been a lot of hoopla surrounding Starbucks' (Nasdaq: SBUX  ) Sept. 21 stock split, which allows us to trot out our classic stock split advice: Don't go bananas.

First, let's explain splits. (Advanced students can race forward to the next section.) Mathematically, they are a zero-sum game. If you own a stock that splits 2-for-1, you now have double the share. So if you bought 100 shares of Big Ape Bananas (ticker symbol: KKONG) at $500 apiece, you now have 200. But each share's price is cut in half, too. Those $500 shares are now worth $250, so you still have $50,000 in Big Ape stock.

How does it affect a company's value? Theoretically, not one whit. Saying a stock split increases the value of your shares is like saying that moving your safety deposit box from a bank in Houston to one in Boston will increase the value of its contents. It's all just a lot of motion. Value-wise, your portfolio ends up in the same place.

Still, people get all wrapped up in the long division. (For more on splits, check our Fool FAQ.)

Calling it splitsville
Recently, two companies had very different experiences with stock splits. When Starbucks announced a two-for-one split, investors rewarded it by driving up the stock price. Still, no matter how you slice it, Starbucks is an $18 billion company -- whether it's 384 million shares at $46 or 768 million shares at $23.

Paid-search specialist LookSmart (Nasdaq: LOOK  ) , on the other hand, caught no such break when it announced a reverse stock split. The $100 million company, with 114 million shares at $0.82, filed with the SEC to recombine into 16.3 million shares at $5.74 apiece.

A reverse split is the same concept as a stock split, only backwards -- the result is fewer shares at a higher price per share. But historically, investors don't see it that way. While a stock split is usually done by a company confident of its business, reverse splits are often a last-ditch effort to get out of penny-stock land.

There aren't any advantages to buying a company just before or after it splits its stock, but that doesn't stop investors from doing so. True, sometimes stocks will run up after or just before a stock split. However, the value creation isn't due to the split, but occurs because the company is probably already trading near its all-time high and looking good.

A stock split is a positive sentiment, but don't worry -- your feelings will soon normalize again.

Keep an eye on splits with this list from For further Foolishness, read:

Dayana Yochim owns none of the companies mentioned in this article. The Fool's disclosure policy is still in one piece.

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