November 2006 - I make no secrets about my love for the morning business section in the local fish wrap (i.e. newspaper) or my unsuccessful run at stock price speculation. My stock picking is so bad of late my colleagues and friends have found investing against me to be quite profitable. This all being said, the curious mind does know one thing for sure; no mater what the list price is, stock prices do not matter. Let me explain.
A few years back while waiting in line for an overpriced latte, I overhead a young man brag to a half listening acquaintance that a stock (of which I’ve never heard of) just split and he was taking his wife out for dinner to celebrate. Being anti-cerebral at the time, I cordially congratulated the gentlemen under my breath and wished to someday be as lucky as he apparently just was.
Five or so years after this experience, I was fortunate to struggle through my first financial accounting course and during an especially arduous homework assignment found that a stock split has no, let me repeat no, economic affect on the stock. Every company issuing stock has a market value, which is simply the total number of issued shares of stock multiplied by the price of the stock. For example, at the time of this writing Google (GOOG) has a market cap of around $143 billion and is trading at $471 a share. This means Google has roughly a little over 300,000 outstanding shares.
A student loan ridden, large mortgage owner, future family man like me has little expendable cash lying around, but if I did I could probably afford ten shares of Google. Let’s say after breaking open my piggy bank and purchasing ten shares of Google, Google decides to split its stock two for one (i.e. two shares for every one share). The result is 600,000 outstanding shares trading at $235.50 and instead of only having ten shares, this curious mind has twenty! Hurray, right?
Now I grew up directly across the street from a corn field in the middle of the upper Midwest and have never once been praised for abnormal intellect. But, I was taught (in the first grade I believe) that ten multiplied by $471 is $4,710 and oddly enough equal to twenty multiplied by $235.50. Consequently, while I may feel wealthy having doubled my stock holdings in Google, in reality I’ve gained absolutely nothing in economic terms.
Of course if you don’t take my word for it, just ask Mr. Warren Buffet whose company “Berkshire Hathaway” was trading (at the time of this writing) for around $105,000 a share. Warren (as I like to call him in person conversing over a Coke) has never split his company’s stock. While I don’t know the exact reasons why, I’m pretty sure he sees a split as needless as I and avoids dealing with superfluous details as such.
In conclusion, do stock prices matter? No, market capitalization matters and your percentage ownership of it. Stock prices are simply arbitrary numbers which can be manipulated to any value wanted.
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I agree in principal. However I wonder if there is not a psychological and administrative effect.
In my interaction with the general population I have noticed many comments such as "Wow Google is at $400!" Or like yourself "My stock is splitting, meaning I own twice as much!" Getting somewhat outside the realm of scientific thought, that would seem to indicate that people like stock prices high and there stocks to split. Thus, that *may* indicate a positive feeling about stocks that are expensive and stocks that split. This may translate in a higher likeliness to buy those stocks...
Beyond that, there is something to be said about liquidity, which of course has value. A cheaper stock is affordable to more people. Thus when its time to close a position, there are more possible buyers. (This is effect maybe somewhat mitigated by the availability of services like ShareBuilder where you can buy partial shares.) Of course, who am I to second guess Warren Buffet?
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