Fool's Eye View

[ May 12, 2000 ]

Baltimore - share price collapses!

By Nigel Roberts (TMFNigel)

Chippenham, Wiltshire -- So, it's 8.30am, I log on to the Fool to check what is happening, as usual, my first port of call is my Fool portfolio, I have to check how my shares are doing. Shock, horror, the shares in my favourite company Baltimore (LSE: BLM) have collapsed. Last night they were £66.50 this morning they were only £6.65, they have lost 90% of their value over night!

Now of course, as an avid Fool, and close follower of the Baltimore message board I know that they have not really lost 90% of their value! The have done a 10-1 spit so while the share price may have fallen by 90%, I now have 10 times as many shares as I had before, so the value of my investment has not changed - phew!

So what is all this about share splits?

I often hear it stated that it would be better to buy the company with the shares valued at £1 rather than the company with shares valued at £50. The theory is that will be easier for the shares valued at £1 to double to £2 than the £50 shares to double to £100. This is of course complete and utter bunk. It makes no difference, in both cases the total value of the company has to double for the share price to double, and the likelihood of that happening is exactly the same for the company no matter what its share price actually is.

I know that many Fools will still not agree with me, but let's try and tackle this from a different direction. Imagine that you have a £50 note, you want to buy some sweets, but you know that you local corner shop won't have enough change: so you decide that you want to split this note up. You go into the bank and get a £20 note, a £10 note and £20 in pound coins. You have split the £50 note up, but you still have £50, just because you have now got more notes and coins you still have £50. It won't buy you any more than before, so spitting up the note has made no difference to the value of the money that you had. It is exactly the same with shares. If a company splits its share price the value of your investment stays EXACTLY the same!

The important thing for all Fools to recognise is that companies split their shares as their market capitalisation grows; splitting the shares does not cause the market capitalisation to grow.

But splitting helps the share price!

There is also some anecdotal evidence that says when a company splits its share price, over a longer term the share price often soon gets back to where it was 'pre-split'. Mmm -- I seem to be contradicting myself! But let's look at this logically.

Why will a company usually split its shares? Well, it is certain that some companies recognise that when the share price gets 'high' relative to other companies' share prices then some investors start to worry about the share price. OK, I have said that in theory it makes no difference, but in practice (and we operate in a market after all) many investors don't like buying small numbers of shares at high prices. But the right question to ask is "why has the share price increased to a high level?" Usually it is because the company has been performing well, producing increasing profits and growing the business. This leads to more people wanting to buy the shares and so an increase in price. When a company splits its shares it has not changed anything else in its business. We know that winning companies very often continue to be winning companies, so it is very likely that the company will continue to perform well in the future, increasing its profits and growing its business; this continues to attract investors and so pushes the share price up.

The act of splitting shares does not generate more wealth, and certainly does not change the business one bit. Stock splits do not lead to increasing share prices over the long term. Improving company performance and investor perception leads to an increased share price -- over the long term -- which may lead to a stock split. After the stock split the company may continue to perform well, increasing profits and growing the business which may lead to increased investor interest, which in turn leads to increased share prices, and possibly another stock split. But the stock split is the result of improved company performance and an increasing share price -- it is not the cause of the increasing share price!

If you don't agree with me please do give some feedback on the Fool's Eye View discussion board, but be prepared for some combative responses if you don't believe me!

Related Links

• Baltimore discussion board
• Growth Investing -- Stock Splits

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