3 – M1L4 04 Corporate Actions V5

The next set of data we’ll talk about is related to events a company can take that affects its shareholders. This data is called Corporate Actions. For this lesson, we’ll describe only two of the many corporate actions. Stock splits and dividends. Let’s start with stock splits. On June 2nd, 1998, you could buy a share of Amazon for about $85. On this date, Amazon decided to perform a two to one stock split. Every Amazon shareholder, had their shares doubled. This does not mean all of their money in Amazon doubled. When a stock is split into two, its price drops by half. This makes sure that the total market capitalization of a stock has not changed by a split. Market capitalization is the dollar value of a company’s outstanding shares. This is calculated by multiplying the stock price by the total number of shares outstanding. In this case, there are twice as many outstanding shares. To keep the market capitalization the same, the stock price has to drop by half. Why would you ever want to split a stock? One reason could be to make the stock more liquid. Less expense of stocks are believed to be more liquid. Current shareholders and potential investors can now buy and sell and more granularity. This helps maintain a healthy volume of transactions. Amazon later went on to have two more stock splits. A three-to-one split on January 5th, 1999. A two-to-one split on September 2nd of the same year. The price dropped to roughly one-third and one-half respectively. I say roughly, because there is still some trading during the day. The closing price ends up being a little different from exactly one-third or one-half, typically, a little higher due to the renewed interest in the stock. If you look at the graph of the stock prices at that time, you’ll notice that the large drops are due to the stock splits. Looking at this graph makes it look like the company dropped in value. Using these prices, a computer would read the data the same way. However, this is not true. The value of the company has not changed from the split. How do you correct for this? One common approach is to normalize the prices to reduce the sudden changes. For instance, you could double the stock price after each two-to-one split, triple after each three-to-one split, and so on. The trouble with that is, your current normalized price will be very different from what the stock is actually trading at. Instead, we’ll do the opposite. We’ll have the price before each two-to-one split, turn it into thirds before any three-to-one split, and so on. Now, the newest adjusted price matches the price currently on the market. Stock prices normalized in this manner is called adjusted price. This is typically provided in most historical data sets. Needless to say, you must keep in mind that this is a distortion of reality. In June of 1988, before the first split, Amazon was not trading at seven dollars. It was trading around $85. It is the repeated adjustments to historical prices that have reduced 85 to $7. With this in mind, let’s learn about the next corporate action, dividend.