Stock splits (tutorial #3)

The closing price of Amazon.com's shares on September 1, 1999 was $119.06. Next day, on September 2, the shares closed trading at a price of $60.06. Hang on a second! This implies a return of ($60.06 - $119.06) / $119.06 = -49.55%, or almost -50%. Don't you think this is a bit strange? The figures seem to suggest that half of Amazon's market value was wiped out in a single trading day. There was no market crash or anything extraordinary on September 2 that would justify such a disastrous return.

The answer to this mystery is simple. The huge change in price was due to a 2-for-1 stock split: each share of Amazon stock was split into 2 shares. This explains why the return on that day was around -50%. If there were x shares outstanding before the split, then there were 2x shares outstanding after the 2-for-1 split. We can easily calculate the post-split share price P assuming that the company's value did not change on that day:

Value before the split = Value after the split

$119.06 x = P (2x)

Solving for P yields $59.53, which is very close to the actual closing price of $60.06 on that day. This means that the company's value changed only slightly on September 2. The return was simply ($60.06 - $59.53) / $59.53 = 0.89%, and not -49.55%.

Next tutorial: Raw vs adjusted prices
Previous tutorial: Total returns

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