Why do stocks split? Companies will often split shares—and, so, prices—to make purchasing the stock cheaper for investors. However, it’s also important to note that a stock that splits is not necessarily a great investment, even if it’s now cheaper.

Why do stocks split? When a company splits its shares, it is simply cutting itself up into a different number of pieces without changing its underlying value. It simply wants its stock to trade in a price-per-share range that seems more reasonable to investors.

If a stock’s price rises much beyond $50 a share or so 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—the new shares will appear in your brokerage account.

Why do stocks split? Drawing attention to the company is one reason

After a conventional stock split, good news often follows. That’s because the stock has typically risen as far as it has on previous good news. So, companies may 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. 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 might not always be followed by good news.

Why do stocks split? What reverse splits mean

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. It’s what usually 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 their given holding represents the same percentage ownership of the company as before the reverse split. 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 and consolidations are a minor investing 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. Those are key parts of our Successful Investor philosophy.

Bonus Tip: “Tune out the noise” to truly find the best investments 

Our long-time subscribers have heard these words of caution before: You need to “tune out the noise” to make profitable investment decisions. This, though, is different from narrowing your view to a handful of indicators. Instead, most successful investors use what you might call “reductive” reasoning.

This is different from the “inductive” and “deductive” reasoning that plays a big role in the study of logic, and in statistical analysis.

When you employ “reductive” reasoning, you keep your eyes open for all sorts of data. But you develop a knack for spotting the near-useless data that fills most daily news reports. You can safely ignore most of it.

You could think of that low-payoff data as “mental chewing gum.” It keeps your mind busy without providing any financial payoff, just as chewing gum keeps your jaw busy without any nutritional payoff.

For example, one time the news media reported that a well-known hedge fund operator had favourable things to say about the outlook for gold, a subject on which he had previously said little. This set off a flurry of reporting: on the price of gold, past gold production, gold’s monetary history, the hedge fund operator’s trading history, his past triumphs and failures, and so on. Some journalists felt his newfound enthusiasm could mark a turning point for the metal.

In contrast, most successful investors ignored all this. They know that nobody gets it right every time when making investment predictions, least of all with a fungible commodity such as gold.

Is a stock split just a “feel good” measure or do you think there is some advantage for existing investors in the stock?