Case Study

In April 1996, directors of the Coca-Cola Company approved a 2-for-1split, the firm's fourth stock split in a decade. The announcement stated that trading in the split shares would begin on May 13, approximately a month after the split was announced. Shares of thefirm's common stock fell by $1.25 with the announcement. Shareholders of Coca-Cola could expect that the stock price would decrease by half when the securities commenced trading on a post-split basis.A stock split results in additional shares of ownership without a corresponding change in total income or assets. All per-share financial statistics decline in proportion to the size of the split.Thus, a 2-for-1 split results in twice the outstanding shares, each with half the book value and half the earnings as prior to the split. In general, stock splits create more paper but not more valuefor shareholders, because the market value of the stock can be expected to fall in proportion to the size of the split. A stock trading at $60 per share just prior to a 4-for-1 split should trade atapproximately $15 per share following the split. Academic research investigating how or when investors can profitably invest in stock split situations offers mixed results. Some research indicates thattrading stock just prior to a split may create unusual profit opportunities. One well-known study finds that unusual returns can be earned in the days before and after the announcement, but not on thedate of the actual split. Other research indicates investors will earn unusually low returns by investing in stock in the year or two following a split. This variability of results means the individualinvestors cannot expect to earn unusual profits by purchasing a stock just prior to or following a split. By the time a split occurs, any unusual profit opportunity has alreadypassed.