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Stock Split

Fifty-five years ago, Warren Buffett bought 2,000 shares of Berkshire Hathaway Inc. (NYSE:BRK-BD) stock for $7.50 per share. Berkshire’s Class A shares just went above $300,000 per share Monday. A little quick math reveals that if you had bought a lot of 100 Berkshire shares in 1962, along with Buffett, your $7,500 investment would be worth (gasp) $30 million today!

Part of the reason (aside from Buffett’s uncanny ability to turn investments into pure gold) for the roughly 4,000,000% increase in Berkshire stock value, is the fact the stock has never split.


Stock Split

A stock split is an action, taken by a company, in which the company divides existing shares into some multiple, to boost the liquidity of the shares. Examples often used are 2-for-1 or 3-for-1. In the first example, an existing share would now become 2 shares. In the second example 1 current share would be exchanged for 3.

The overall value doesn’t change. Think of example #1 as trading one $10 bill for two $5 bills. If the original stock, in a 2-for-1 split is worth $20, each resulting share is now worth $10.

Why Companies Do This

If the value, including market capitalization of the company, doesn’t change, why would a company undertake a stock split in the first place? When stock prices get above a certain amount, it becomes expensive for an investor to buy a standard board lot of 100 shares. Splitting the stock makes investing cheaper and therefore accessible to more people.

Also, when the price per share is cut in half (or more) the liquidity for the stock goes up. That’s because the number of buyers for that stock at $50 per share is likely greater than the number of buyers at $100. (Remember a lot of $100 shares would cost $10,000. A lot of $50 shares would cost half that ($5,000).

Reverse Stock Split

A reverse stock split is the opposite of a stock split, also known as a forward stock split. In a reverse stock split shares are combined to raise the “per-share” price. A company could execute a reverse stock split if the share price had declined to the point where the company’s stock was in danger of being delisted on the stock exchange.

A reverse stock split is also often executed to attract investors who might not be interested in a company whose stock sold for a couple of dollars but would be interested in one priced at $10 per share, for example.


The Psychology

Mostly stock splits are a psychological move on the part of a company to – in a way – manipulate share price to increase interest, attract investors and make the company look better and more attractive. In addition, a split creates a positive life for existing investors who now feel they have more value in the form of a greater number of shares.

Psychology also plays into Warren Buffett’s reluctance to split Class A shares of Berkshire Hathaway. In this case, it has nothing to do with making those shares more liquid or more attractive to investors but with the sense of pride held by Buffett and fellow shareholders that they have the single most expensive stock on the planet. As Buffett says, “I can gear my whole life by the price of Berkshire.”

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