A stock split is often issued after the price of a company's stock has risen significantly over time. Investors who sell shares prior to a split are likely to be earning profits from a stock that was very highly priced. Subsequently, the returns are likely to be generous as long as the shares were purchased at a lower price level. There is also an advantage to selling stock prior to a reverse split, although the benefit is primarily to protect against any losses.
One of the main types of stock splits is a two-for-one split. In this transaction, investors receive two shares of stock in exchange for every one share they own. The value of an investor's total holdings does not change. Instead, the price for each individual share drops, while the number of shares owned increases by the same proportion. Management teams must receive approval from a board of directors to perform a stock split. A split typically occurs when a stock price has risen significantly. A high stock price can have a psychological effect on investors, causing them to think it's too expensive. Because a stock split lowers the price per share, it often seems more affordable to investors.
The management teams of certain corporations may allude to the fact that a stock split will eventually occur but investors do not typically have insight into precisely when or how the deal will be performed. Subsequently, it may be difficult to determine the best timing for selling shares in anticipation of a split. Although technology giant Apple has a history of performing stock splits, investors were left to wonder whether or not another split was imminent when the stock price reattained lofty levels.
Once a stock split has been announced, the market value for the stock often increases. An investor still has an opportunity to sell shares without participating in the split, however. When Aetna issued a stock split in 2006, the stock continued to trade at the presplit price in what's known as the regular way market for a number of days. Investors were still able to sell shares. An investor who decides to sell shares in the regular way is potentially enjoying greater profits due to the immediate gain that can occur after a split is announced.
Investors can attain the greatest advantages by selling stocks prior to a reverse stock split. In a reverse split, the number of shares decreases while the price per share increases. The total value of an investor's holdings does not change in a reverse split. It's the perception that changes, because the price of the stock is driven higher. It's possible that a company performing a reverse split is making a last-ditch effort to improve the sentiment surrounding a stock. Investors might benefit from selling the stock and avoid any potential roadblocks ahead.
Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.