Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you specific advice to help you make better stock market investments. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.
Today’s tip: “How you share splits affect your stock market investments”
When a company splits its shares, it is simply cutting itself up into a different number of pieces, without changing its fundamental value. It simply wants its stock to trade in a price-per-share range that seems reasonable to investors.
For example, in the June 30, 2011 Stock Pickers Digest Hotline, we took a fresh look at Computer Modelling Group Ltd. (symbol CMG on Toronto). That’s because the company had just split its shares on a 2-for-1 basis. Computer Modelling makes software and supplies services that help its clients get as much oil as possible from their existing wells.
Prior to its share split, Computer Modelling Group was trading at around $25 a share; it now trades at a more reasonable $13.25 a share.
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If a stock market investment’s share price rises too high, some investors may shun it, since it seems expensive. The company’s management may then declare a stock split of, say, 2-for-1 (as was the case with Computer Modelling).
This turns one “old” share into two “new” shares. That’s why Computer Modelling’s share split increased its shares outstanding to 36.48 million from 18.24 million. However, the stock market investment’s market capitalization (the shares outstanding times the share price) is unchanged at $480.3 million.
If you are a Computer Modelling shareholder, your percentage ownership of the company is unchanged — you hold twice as many shares, but you still own the same percentage of the total.
In short, a share split does not dilute your interest. Dilution usually occurs when a company issues shares for less than the current trading price. For example, if employees exercise options to buy shares at a discount or below the market price, dilution occurs. Each of your shares is now worth slightly less than it was before. This also happens when holders of convertible securities exercise their conversion privileges and exchange their securities for shares at less-than-market prices.
Share splits are often a good way for stock market investments to attract attention
After a conventional stock split, good news often follows. Companies mainly split their shares when they want to draw attention to themselves — because they expect earnings to rise faster than normal, say. At such times, they may also raise their dividends.
That was the case in March 2011, when Potash Corp. (symbol POT on Toronto) split its shares on a 3-for-1 basis. Immediately following the split, the company raised its quarterly dividend by 110.0%, to $0.07 U.S. (post-split) from $0.033 U.S. The new annual rate of $0.28 U.S. (post-split) yields 0.47%
Our investing advice: Stock splits are a minor detail. Don’t let them distract you from more important matters, such as a company’s fundamental value and how well it suits your investment objectives.
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