What are Splits and Buybacks – an explanation

Tuesday, September 15, 2009, 10:21 AM | Leave Comment

A while back, I read online about a company’s stock being split and another had announced buybacks of its shares.

Some financial experts had commented on that news without realizing to explain what these two terms actually mean.

So I did some research and here is the description in simple terms what they mean.

Stock Splits

I am sure you have heard of a company stock being split. What does it actually mean and under what circumstances is it done? The company’s board of directors picks up a financial axe and split the stock. And the reason is that the price has gone upward to such height that many folks just cannot own it. The splitting, when occurs, distributes additional shares to existing shareholders.

The most common split is two-for-one, in which each share becomes two shares. The price per share immediately adjusts to reflect the change, since buyers and sellers of the stock all know about the split

High stock prices are problematic for companies because they make it seem as though the stock is too expensive. By splitting a stock, companies hope to make their equity more attractive, especially to those investors that could not afford the high price.

Not only does the split tend to increase demand for shares by making the shares more accessible to small investors, it also usually garners favorable media attention. This tends to cause the price of a stock that has split to increase after the split.

Stock Buybacks

Sometimes a corporation repurchases it stocks and bonds that it has previously issued. In the case of stocks, this reduces the number of shares outstanding, giving each remaining shareholder a larger percentage ownership of the company. This is usually considered a sign that the company’s management is optimistic about the future and believes that the current share price is undervalued.

In a Nutshell
The split is interpreted by some as a sign that the company’s management is confident that the stock’s price will continue to rise. Of course, there is no guarantee that this will happen.

Some companies announce buyback plans as a sign of confidence, but it’s meaningless unless they actually go through with the repurchase.

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