Coupons. A penny saved is a penny earned. Do not feel embarrassed about using a coupon that is only fifty cents discounted off the original price. This saving can contribute to paying off some of your ridiculous transaction commissions that our online trading broker website robs from us (E-Trade, Scott-Trade, etc.). Eight dollars for a transaction just to buy some stocks and another eight just to sell them? That’s absurd, especially if you haven’t made any profit from the stock. These commissions do contribute to losses and minimizes our profits! So every penny saved helps.

But watch out for those coupons. They can be evil sometimes. In a sense, coupons lure you in to buy the items that you might not need at all. This again relates to trading: don’t buy a stock simply because it looks good, without appropriately studying the stock or having a reasonable trading method. Just like how you shouldn’t use the coupon because the item is at a cheaper price, you should not buy a stock simply because it is cheap. For example: penny stocks. Most of us can afford to buy a couple of penny stocks but why do we not? There is a very high risk to them and therefore, we cannot associate buying something only because they’re cheap. Cheap prices are attractive but sometimes we need to control our desires if we still want to have some decent amount of money in our bank.

Also, just because an item has dropped in price (perhaps due to the coupon or a sale), which makes it cheaper than it initially was, does not mean that you should buy it. Many of us do so because we believe that the price of the item will go back up so we tend to take advantage of sales and coupons, even for those items that we do not need. However, we have to be careful to not use the same method when it comes to trading! It is so easy to get attracted to cheap, fallen prices but remember: We cannot buy a stock just because it has dropped in price, thinking foolishly that the stock “has” to go back up with no apparent reason other than that it “has” to! That would be speculation. What comes up most often comes down at times, but what comes down…unfortunately does not always come back up all the time (as you can probably tell from all our bankrupt companies). Therefore, we cannot assume that the stock price will go up. The stock market has no guarantees: the stock can keep going down and disappear…and so can your investments.

I agree that the idea of buying a large block of $1, $2, or $5 stock and watching it double is exciting. The only problem is that your odds of winning the lottery may be better. Here’s the fact: investing in stocks is not the same thing as buying a car or a shirt on sale. Cheap stocks involve far greater risk. A historical fact is that of best-performing stocks in the last 45 years, the average per share price before it doubled or tripled was $28 a share.

Given this comparison between coupons, sales, and trading, I hope you do not let prices and its mere appearance (without studying, perhaps, fundamental analysis or technical analysis) affect your decision whether or not to buy a stock. Think before you act.

A stock split is an action that companies might decide to do especially if their stock has been very successful. A stock split would increase the number of shares outstanding by dividing them into multiple shares to be traded publicly. However, this does not change the total market capitalization (the total market value).
[Total market capitalization is calculated by: # of shares outstanding X price per share].

For example, suppose company XYZ has a total of 20 million shares of stock outstanding at the price of $50 per share. If XYZ’s board of directors decided to do a two-for-one split and the shareholders approved it, they can increase the number of shares outstanding from 20 million to 40 million, which would then cause its price to decrease from $50 to $25 per share. In both cases, the market capitalization does not change as shown below:

1) Before- 20 million shares outstanding X $50 per share = 1000 million (market value)
2) After- 40 million shares outstanding X $25 per share = 1000 million (market value)

[Here Company XYZ has decided on a 2-for-1 split, meaning that each stockholder receives an additonal share for each share that he/she already holds.]

So, what’s the difference between the two scenarios? After the stock split, current shareholders have twice as many shares, and new investors can buy shares at a lower price. Stocks can be split in any number of ways: two-for-one (as shown in the example above), three-for-two, three-for-one, etc.

What are possible reasons why a company would decide this? One primarily reason is to stimulate trading and to enable smaller investors to buy shares since the shares would now cost at a lower price than initially. Since most investors buy shares in round lots (e.g. a block of 100 shares) because commissions are higher for odd lot transactions (e.g. block of anywhere from 1-99 shares), it can be difficult for smaller investors to buy shares of a company whose stock is priced at $200. However, if that company splits its shares five-to-one, the price would drop to $40 per share, making it easier for smaller investors to buy that company’s stock. Again, the market value of the company hasn’t changed, but the total number of outstanding shares has increased by a factor of five.

Many times, a stock’s price will rise somewhat after a split, perhaps because investors become more interested in the stock, causing a wave of buying. Also, generally, a stock split is perceived as a positive indicator for a stock and the company, because stocks that are doing poorly usually are priced low to begin with.

Next Lesson: Reverse split!