Rule #1 Finance Blog

With Investor Phil Town

HOW STOCK SPLITS WORK

Last week, Jonathan Welsh — who’s doing his Homework on Toll Brothers, the luxury home builders — contacted me with the following question about a 2-for-1 split. I figured a lot of people would have the same question:  with 2-for-1, do you really get more for your money — double the shares? Here’s his question and my response.


On 6/14/05, jonathan welsh wrote:

The current sticker price you calculated for Toll was 105/share. It is currently selling at 96/share, which is not even close to the 50% requirement. Toll is having a 2-for-1 split on the 21st of June 2005. With a 2-for-1 wouldn’t that get me the same result?  I am kind of new to the concept of getting one additional share to each share held, but doesn’t that count as doubling your money?

God  bless!

Jon Welsh

Date: Jun 16, 2005
Subject: Re: toll 2 for 1
To: jonathan welsh

Good question, Jonathan.  The short answer is no.

Here’s the why not: 

Stock splits are the same as taking a dollar and splitting it into two fifty cent pieces.  You still have a dollar of value but it’s been broken into more easily traded currency.  Stock is split so that it can be more easily bought in blocks of 100 shares by options traders, people doing covered calls and so on.  It is just an accounting process, not a real change in price. 

Shortly after the stock split you will see the entire charted history of TOL change to reflect the new price per share relationship.  That means that the stock chart which showed the price at $100 in June, will now show it at $50 in June.  Everything else that is calculated on a per share basis like EPS will be recalculated to reflect the new number of shares.  But the actual value of the business stayed the same. 

So.  All your calculations that were done on the old EPS of $6 will be redone to reflect the new EPS of $3.  The old Sticker of $100 become $50.  The old MOS of $50 becomes $25.

Make sense?

Phil