2 Common Stock Market Strategies Companies Utilize

Plus, some of the reasoning behind them

Assistant Editor
Apr 8, 2021 at 3:26 PM
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    As an investor, there are two strategies made by companies that you should be aware of: 1) buybacks and 2) stock splits. A stock buyback, at its essence, is when a company repurchases its own stock. This typically boosts the immediate value of the stock, since there are less shares available to trade in the market. A stock split, on the other hand, increases the number of outstanding shares by splitting them (most commonly in the way of 2-for-1 or 3-for-1), which investors often see as long-term strength. 

    Buybacks

    One reason companies may buy back their stock is if they think it is significantly undervalued, reminiscent of currency inflation, which is certainly a bullish signal for shareholders. Two other reasons are 1) to utilize excess cash, as a way of way of returning extra cash flow back to investors and 2) for tax purposes, giving shareholders a way to defer capital gains. However, it's also important to be wary, as there are companies that will artificially boost their stock price this way, sometimes in order to raise it in the short-term. 

    Stock Splits

    A stock split, which again, divides one share into multiple, is usually the result of strong price action, pointing to overall health. Giving the shares more attractive prices appeals to a wider range of investors, and the move also improves the stock's liquidity, which refers to the speed at which a stock can be bought or sold without affecting its price. Though stock splits have no effect on the fundamental value of the stock, many still note positive sentiment surrounding them. 

    Drilling down, here is how it works: 

    For example, if stock XYZ is trading at $90 per share with 1,000,000 available common shares of stock, its market capitalization would be $90 million. Splitting its stock 2 for 1, there would now be 2,000,000 shares of stock, each shareholder holds twice as many shares, the price of each of which is adjusted to $45. The market capitalization remains the same at $90 million.

    Reverse stock splits, on the other hand, are the direct opposite. As you could have guessed at this point, this is often done to raise the stock's price. In many cases following a reverse stock split, however, the stock price will actually decline, and there has been some academic research proving as much.  

     

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