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Stock Split is an accounting procedure initiated by the Board of Directors to change the price of a stock so it is more palatable for the intended shareholder base.
In a 2-for-1 split, the number of shares doubles and the price is cut in half.
To illustrate why no value is created, imagine splitting a pie into 8 pieces instead of 4. If a pie is worth $8, in four pieces the value is $2 per slice, and in 8 pieces the price is $1 per slice. So there is no change in value.
In what is called a reverse share split the opposite is the case. For example, a 1-for-2 split would decrease the number of shares by half and double the price. Management might want to enact this if their share price is too low, as happened with Citigroup stock after the Financial Crisis in 2008-2009.
Some active managers interpret stock splits as evidence of confidence from management and expect positive abnormal returns after the announcement of the split, but this point is debated in academic circles. There is some near-term evidence of outperformance, but over long periods of time these disappear.
For context, in a way, understanding the dynamics of stock splits is easy, and in my mind it is like understanding conjugations like "it's" versus "its" and "we're" versus "were", sometimes you have to think about it, but using the wrong one is a credibility killer. So make sure you know the takeaways about stock splits.
Doc: Tom, will you explain to the class the
concept of a stock split?
Tom: A whole pizza pie sells for $16, or two halves for 8 bucks each.
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False. Expensive is a valuation concept, price doesn't matter because you can always change the number of shares.
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