Saturday, November 04, 2006
Sticker shock and stock splits
Sticker shock and stock splits
Sticker shock is an amazing phenomenon that continues to baffle me. Why people are willing to pay $.99 for 6 eggs but not $1.29 for 12 makes me wonder about modern society.
A more likely example:
The increase in gas prices has left people “in a tizzy.” An increase of five cents a gallon will send people into chaos while when their cell phone bills go over $50 the same people don’t seem to have a care in the world.
A recent prize drawing for $100 at a certain local bank generated no interest. Its $100, you’re in a bank where you probably have several times more stored away. I mean, its just $100 right?
A very similar, just as advertised give-a-way is announced where winners will receive a $100 gas card. Whoa, $100 in GAS? That’s awesome, in the US that is about 40 gallons. Everyone and their brother’s dog is there to sign up for the chance to win $100 (in free gas.)
Another thing, the American Express gift cards that can be spent ANYWHERE where American Express is taken, which for the most part, is everywhere. Believe it or not, currency can be spent anywhere within the country or continent (euro) it is representing. An American Express card is seen as such a great alternative to giving cash, even though in reality it is the same thing.
The gas card was effectively worth less than the $100 cash because cash has the potential to be spent on other necessities. Gas can only be used by a small range of things. But since the price of gas is relatively high, the gas card looked better than cash even though cash has more utility.
What does this have to do with the markets?
Stock splits happen all the time. Usually stock splits are meant to increase the amount of shares and proportionately revalue the price of each share. Reverse splits also occur which do the exact opposite, lower the amount of shares and raise the price.
Stock splits allow investors the chance to get involved in a company with less money than usually required. (Most brokerages will not allow you to buy portions of shares, although some discount online brokers offer this service).
A stock priced at $100 is pretty expensive relative to the price of other stocks in the US. If the stock was split 4 for 1, the stock price would drop to $25 per share and everyone would own four times as many shares. Basically, nothing happens, you still have the same amount of money.
After stock splits however, investors tend to look at the stock more. For one reason or another it seems as though after every stock split the stock rises several percentage points. Stock splits seem to renew interest in the shares and send prices soaring.
Reverse splits do the exact opposite. Usually reverse splits only occur because the company has to keep a minimum share price in order to stay on a certain exchange. Many stocks on the AMEX stock exchange have to do this because the AMEX requires that stocks have a value of $1 per share. If any less than $1 the company can be booted off the exchange.
After a reverse split goes through, the price of the new shares always drops. Just like a normal split, the stock price is affected by renewed interest/disinterest in the stock.
Pricing has a huge effect on the overall markets. Watch what happens after your favorite stock splits. I would bet that in the few weeks following the split the stock will have risen a considerable amount, usually a few percentage points.