Yesterday (2/26/2013), Apple stock was doing its usual thing (going down) and then all of a sudden a rumor circulated that the company might announce a stock split at their shareholder meeting today. You can see the chart below that almost instantly, the stock rose and continued going up the rest of the day.
There has not been much good news for Apple lately so investors are quick to latch on to anything that seems positive. But is a stock split really a good thing and if so, why?
Technically, a stock split is meaningless. If you have 100 shares at a stock costing $500, after a 2 for one split you will have 200 shares costing $250. Your shares are still worth the same $50,000 even though you now have double the numbers of shares. Occasionally stocks split 3 for 1 or some other ratio but the principle is the same: you have more shares but at a lesser value all equalling the same total holdings.
But many investors think stock splits are a good thing for two major reasons:
1) When a stock splits the price per share goes down and makes the stock more affordable for a greater number of investors. In Apple's case, that would mean more people would be able to afford a $230 stock than a $460 stock. More people being able to afford the stock = more people buying it = the stock has a greater chance of going up from that point.
2) A stock split is considered a vote of confidence by the company that splits. That is because they are lowering the price of each share with no worry that the price will go down from there. The management of a company that has an uncertain future will never split its stock because they want to keep the stock as high as possible and they know it may go down on its own if good earnings aren't achieved. Therefore, a company that splits its stock must have a positive future outlook by management.
While both of these reasons may be valid, there is really no concrete proof that either is real. I am not aware of any study or research that has proven that a stock that splits has a better chance of doing well than if it hadn't split. I don't know how you could really prove it anyway.
Mostly it is believed to be true and I concur that in my mind, a stock splitting 2 for 1 is good news. I think it generally means positive things for a stock and I am happy when any stock I own splits.
Conversely, a reverse stock split (where the exact opposite happens and you have less stock at a higher value) usually only happens when a company is encountering tough times and needs to raise the price of their stock to make it more presentable. Stocks that drift into single digits are usually the best candidates to do a reverse stock split if management wants to get the stock price higher and back into double digits. Again it technically means nothing but a $16 dollar stock usually looks better in the mind of investors than an $8 stock so it is for appearances only that a stock will reverse split.