Utilize our stock split definition and more to help you boost shareholder returns—plus a look at spinoffs

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 lower price-per-share range that seems reasonable to investors.

There is more to know about a stock split definition. Read on to discover what that is—plus a look at how spinoffs can add true value for shareholders.

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Here’s a stock split definition and information on the mechanics of splits

What leads to a company splitting its shares? If a stock’s price rises much beyond around $50 a share in Canada (or perhaps $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. The total value is the same. Note that you don’t need to take any action.

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. 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 for your stock market investing, depending on the details.

Traditionally, many companies split their shares when they rose over a certain price point, say, as mentioned, $50 or $100. They felt that the time and money it takes to implement a split was outweighed by the benefit of making it easier for small investors to buy shares.

Look for spin-offs to boost your shareholder value, not share splits

Some investors love share splits and rush to purchase stocks that they believe plan to split. While you may pick some winners, we feel that spinoffs are a much better way to profit.

A spinoff is when a division of a business spins off into its own company. A number of studies have shown that after an initial adjustment period of a few months, spinoffs tend to outperform groups of comparable stocks for several years. For that matter, the parent companies also tend to outperform comparable firms for several years after a spinoff. That above-average performance makes sense for a couple of reasons.

First, company managers naturally prefer to acquire or expand their assets, not get rid of them. Getting rid of assets reduces a company’s total potential profit, which reduces the funds it has available to pay its managers. The management of a parent company will only hand out a subsidiary to its own investors if it’s fairly confident that the subsidiary, and the parent, will be better off after the spinoff than before.

Second, spinoffs involve a lot of work and legal fees. The parent will only spin off the unwanted subsidiary if it can’t sell the stock for what it feels it’s worth. That’s why companies only have an incentive to do spinoffs under two sets of favourable conditions: When they feel it isn’t a good time to sell (which often means it’s a good time to buy); or, when they feel the assets they plan to spin off will be worth substantially more in the future, possibly within a few years.

Oddly enough, many investors treat spinoffs as a nuisance, because they leave you with a tiny holding in a stock you didn’t choose and know little about. This is contrary to how investors feel about share splits.

Both share splits and spinoffs can help you increase your wealth. But in general, share 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.

Use our three-part Successful Investor approach to make the best investments available to you

• Invest mainly in well-established, mostly dividend-paying companies;
• Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities);
• Downplay or avoid stocks in the broker/media limelight.

What is your opinion of stock splits? Do you feel they make a difference in your portfolio?