How to Profit from Stock Splits

There are two different kinds of stock splits: a normal stock split and a reverse stock split. A normal stock split is where a share of stock is divided into more shares of stock, all with a value proportionally less. For example, if you owned a share of stock worth $50 and it split two for one, you would now own two shares of stock worth $25 each. The other kind of stock split is a reverse stock split, where the amount of shares you own are made into bigger shares and worth more per share. In this case, if you owned 2 shares of stock worth $20 each and a 2-1 reverse stock split was done, you would now own one share of stock worth $40.

How Stock Splits Occur

Stock splits can be done at any ratio, not just two for one. Many times, you'll see a stock split three for two, where you'll receive one additional share for each two you own, but they'll be worth 66% of the original price. Sometimes you'll see stock splits occur at rates even as high as 10-1 on hot stocks, which would bring a stock's value from $100 to $10 each.

The Market Favors Some Splits

Regular stock splits are well perceived by the stock market because they show that the company is poised for growth and making shares available to any budget. The price of a stock almost always rallies after a stock split because more people are willing to buy a share of stock at $50 than they are at $500. The larger the split, the bigger the gains that follow. Stocks that regularly split are a favorite among long term investors, who can slowly build a bigger position as a stock splits over and over. Stock splits keep a stock cheap and always prove to bump up a share of stock after the split occurs.

Reverse Splits are Hated by the Market

Reverse splits are absolutely hated by the market because they show weakness. There really is no reason to do a reverse split unless the corporation is trying to reduce shareholders, or has to keep its stock price up to avoid delisting. The major stock markets only carry stocks that trade with a share value of a certain amount. The New York Stock Exchange and the NASDAQ only accept stocks that trade for a value greater than $1 per share. If a stock falls below $1, it must quickly climb back over $1 per share or be delisted from the stock exchange after a long period of time under $1 per share.

Many corporations will then do a reverse stock split to pump the price back up to $1 per share, if the stock trades at $.25 per share, a four to one reverse stock split will be completed to bump the price to $1 per share. Traders will likely hop onto the news as a bad sign and start selling off the stock again. For whatever reason, the stock market is never kind to stocks that do a reverse stock split.

Keeping a close eye out for potential stock splits can help you grow your portfolio positions, but should a sign of a reverse stock split surface, you may want to consider selling your shares, as the prices will most likely suffer once the reverse split occurs.