The Importance of Being Split Adjusted

When a stock quote is split adjusted, the price is established based on considerations of stock splits that have occurred in the past. This means the historical data and current price of the stock reflect the number of outstanding shares. A stock is not actually "split adjusted" itself; rather, the price of the stock and its historical prices have been adjusted to give a clearer picture of the actual growth and profit of the stock over time.

Why do Stocks Split?

With any publicly traded company, a corporation can increase the number of outstanding shares by splitting those shares. For example, imagine you need $10 to buy lunch, and you are willing to write an IOU for that $10. You cannot find anyone to lend you the money, so you decide to ask two people for $6 each. You have split the stock you are offering. Now imagine you find someone to let you borrow $6, issue the IOU with interest, but cannot find anyone to loan you the additional $6 you are looking for. So, you divide that $6 into two sets of $4, and you increase the amount of interest you are willing to pay. You then will go back to the initial lender and change out his $6 IOU for two, $4 IOU's. The initial lender has made a greater profit from the split, and the price of his share has been "split adjusted."

Example of a Split Adjusted Price

In the real world, split adjustments are not that different from this model, but the potential profits from a stock split are much greater. Imagine a company issued stock for $10, just 20 years ago. The stock has split twice at the ratio of two to one. Now, the stock is trading at $20 a share. How much has an initial investor earned? Your initial thought may be a 50 percent return, but this is not accurate. In fact, one share of the company's initial stock is now the equivalent of eight shares of its stock. This means the individual is holding $160 worth of the company's stock. The growth is much higher than 50 percent thanks to split-adjusted accounting.

Affect of a Split Adjusted Price

On the market as a whole, split adjusted pricing helps investors understand the true growth of a stock overtime. If you are considering buying the stock described above, you would get an inaccurate depiction of the stock if you were not looking at the split adjusted price. You would think it grew at a much smaller rate than it actually did, which may lead you to pick another stock instead. You should always consider the affect of a split on the actual growth of a stock in order to get an idea of what an investor earned over the period of time. However, it can be risky to buy stock hoping it will split again. Splits are not common, and some stocks will never split.

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