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 investment advice, including specific stock investing tips. 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: “A share split may make a stock more attractive to many investors, but it’s far from the most important reason to buy a stock.”

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.

Mechanics of a split: If a stock’s price rises much beyond $50 a share in Canada (or $100 a share in the U.S.), some investors may shun it since it seems expensive. The company’s management may then declare a stock split of, say, two-for-one. This turns one ‘old’ share into two ‘new’ shares. If you owned 100 shares of a $60 stock, you now own 200 shares of a $30 stock.

You don’t need to take any action. When you sell your shares and they get re-registered in the new owner’s name, the registrar will issue a new certificate for the proper number of shares.

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 the dividend. However, sometimes companies get overly optimistic. Their profits come in far below expectations, and they can’t keep paying the new, higher dividend. So a stock split can be good or bad, depending on details.

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Reverse split often followed by a fall in the share price

If the value of a stock collapses to pennies a share, investors may think it is headed for zero. To bring its share price back up to more respectable levels, the company may declare a reverse split: five, 10 or more ‘old’ shares will then turn into one ‘new’ share. This ‘reverse split’ is also called a ‘share consolidation’. This often happens to penny mining companies that have spent all their money without finding any valuable mineral deposits.

After a reverse split, stock prices often fall back down again. Some investors sell because the stock seems more expensive than it was, even though a given holding represents the same percentage ownership of the company. Others sell because they fear the company will raise money by selling new shares, and this will drive down its stock price.

Remember, stock splits or consolidations are just one detail. Don’t let them distract you from more crucial matters such as a company’s fundamental value and how well it suits your investment objectives.

COMMENTS PLEASE—Share your investment knowledge and opinions with fellow TSINetwork.ca members

Have you ever bought a stock because it split its shares? Did you already like the stock but feel that it was a bit rich at the higher price? Did it turn out to be a good buy? Let us know what you think.