Why Do Companies Split Their Stock?

Stock splits don't actually change the intrinsic value of a stock, but they do often create euphoria among shareholders and potential buyers that can propel a stock's price sharply higher. Does it make sense that splits can cause such a stir?

A stock split occurs when a company divides a stock's price by a ratio relative to the number of additional shares being issued - say 2-for-1. Regardless of the ratio, the stock price will decline and the quantity of shares outstanding will increase. It's no different than changing two $5 bills for one $10 bill. Two $5's for a $10? Why bother?

Corporate executives know that stock splits are among the most powerful and cost effective marketing tools ever invented. Splits make shareholders feel great and leave them with a sense of greater wealth - all with little expense to the company.

The primary motivation for a company to split its stock is to make the price more attractive to the average retail investor. The reasoning is that more people will want to buy a stock at $50 than $100. To some it just makes more sense to pay the same commission to buy 100 shares of a $50 stock, than just 50 shares of $100 stock. Admittedly this is mostly psychological - but the essence of the entire market IS psychological. Further, as more people buy the stock at the lower price, the stock tends to rise in price. This is called the "split effect" - an important factor in causing the "euphoria" mentioned above.