STOCK MARKET

Commentary: With the recent strength in the U.S. dollar, gold and the companies that mine it have been mired in a correction. While these stocks have been correcting their move to recovery highs since late last fall, from a broader perspective it's clear that these stocks have technically been in a wide-trading range. The mining stocks recently tested the bottom of the range and turned higher, hinting that an end to the correction could be near. Currently, the gold miners are in a critical area on their charts, with a break above near-term resistance hinting at a resumption of the uptrend, and a move lower hinting at a larger topping process.

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In examining the chart of the Market Vectors Gold Miners ETF (NYSE:GDX), you can see the move to new highs in November and the failure to hold the breakout. GDX then proceeded to correct in three waves lower into the February low. Stepping back, you can see that this is all part of a larger trading range taking place from September to the present. GDX dipped under support in February, which could have shaken out some longs. It quickly snapped back into the base and is on its way to testing a resistance level near $47.50. GDX has cleared the 50-day moving average and a recent high. These are bullish clues, and could hint at an upside breakout.

Source: StockCharts.com

Source: StockCharts.com

Source: StockCharts.com

Source: StockCharts.com

A stock split is a corporate action that increases the number of the corporation's outstanding shares by dividing each share, which in turn diminishes its price. The stock's market capitalization, however, remains the same, just like the value of the $100 bill does not change if it is exchanged for two $50s. For example, with a 2-for-1 stock split, each stockholder receives an additional share for each share held, but the value of each share is reduced by half: two shares now equal the original value of one share before the split.

Let's say stock A is trading at $40 and has 10 million shares issued, which gives it a market capitalization of $400 million ($40 x 10 million shares). The company then decides to implement a 2-for-1 stock split. For each share shareholders currently own, they receive one share, deposited directly into their brokerage account. They now have two shares for each one previously held, but the price of the stock is split by 50%, from $40 to $20. Notice that the market capitalization stays the same - it has doubled the amount of stocks outstanding to 20 million while simultaneously reducing the stock price by 50% to $20 for a capitalization of $400 million. The true value of the company hasn't changed one bit.

The most common stock splits are, 2-for-1, 3-for-2 and 3-for-1. An easy way to determine the new stock price is to divide the previous stock price by the split ratio. In the case of our example, divide $40 by 2 and we get the new trading price of $20. If a stock were to split 3-for-2, we'd do the same thing: 40/(3/2) = 40/1.5 = $26.6.

It is also possible to have a reverse stock split: a 1-for-10 means that for every ten shares you own, you get one share. Below we illustrate exactly what happens with the most popular splits in regards to number of shares, share price and market cap of the company splitting its shares.

What's the Point of a Stock Split?

So, if the value of the stock doesn't change, what motivates a company to split its stock? Good question. There are several reasons companies consider carrying out this corporate action.

The first reason is psychology. As the price of a stock gets higher and higher, some investors may feel the price is too high for them to buy, or small investors may feel it is unaffordable. Splitting the stock brings the share price down to a more "attractive" level. The effect here is purely psychological. The actual value of the stock doesn't change one bit, but the lower stock price may affect the way the stock is perceived and therefore entice new investors. Splitting the stock also gives existing shareholders the feeling that they suddenly have more shares than they did before, and of course, if the prices rises, they have more stock to trade.

Another reason, and arguably a more logical one, for splitting a stock is to increase a stock's liquidity, which increases with the stock's number of outstanding shares. You see, when stocks get into the hundreds of dollars per share, very large bid/ask spreads can result (see Why the Bid/Ask Spread Is So Important.). A perfect example is Warren Buffett's Berkshire Hathaway, which has never had a stock split. At times, Berkshire stock has traded at nearly $100,000 and its bid/ask spread can often be over $1,000. By splitting shares a lower bid/ask spread is often achieved, thereby increasing liquidity.

None of these reasons or potential effects that we've mentioned agree with financial theory, however. If you ask a finance professor, he or she will likely tell you that splits are totally irrelevant - yet companies still do it. Splits are a good demonstration of how the actions of companies and the behaviors of investors do not always fall into line with financial theory. This very fact has opened up a wide and relatively new area of financial study called behavioral finance (see Taking A Chance On Behavorial Finance.).

Advantages for Investors
There are plenty of arguments over whether a stock split is an advantage or disadvantage to investors. One side says a stock split is a good buying indicator, signaling that the company's share price is increasing and therefore doing very well. This may be true, but on the other hand, you can't get around the fact that a stock split has no affect on the fundamental value of the stock and therefore poses no real advantage to investors. Despite this fact the investment newsletter business has taken note of the often positive sentiment surrounding a stock split. There are entire publications devoted to tracking stocks that split and attempting to profit from the bullish nature of the splits. Critics would say that this strategy is by no means a time-tested one and questionably successful at best.

Factoring in Commissions
Historically, buying before the split was a good strategy because of commissions that were weighted by the number of shares you bought. It was advantageous only because it saved you money on commissions. This isn't such an advantage today because most brokers offer a flat fee for commissions, so you pay the same amount whether you buy 10 shares or 1,000 shares. Some online brokers have a limit of 2,000 or 5,000 shares for that flat rate, but most investors don't buy that many shares at once. The flat rate therefore covers most trades, so it does not matter if you buy pre-split or post-split.

Conclusion
The most important thing to know about stock splits is that there is no effect on the worth (as measured by market capitalization) of the company. A stock split should not be the deciding factor that entices you into buying a stock. While there are some psychological reasons why companies will split their stock, the split doesn't change any of the business fundamentals. In the end, whether you have two $50 bills or one $100 bill, you have the same amount in the bank.

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All publicly-traded companies have a set number of shares that are outstanding on the stock market. A stock split is a decision by the company's board of directors to increase the number of shares that are outstanding by issuing more shares to current shareholders. For example, in a 2-for-1 stock split, every shareholder with one stock is given an additional share. So, if a company had 10 million shares outstanding before the split, it will have 20 million shares outstanding after a 2-for-1 split. 

A stock's price is also affected by a stock split. After a split, the stock price will be reduced since the number of shares outstanding has increased. In the example of a 2-for-1 split, the share price will be halved. Thus, although the number of outstanding shares and the stock price change, the market capitalization remains constant.

A stock split is usually done by companies that have seen their share price increase to levels that are either too high or are beyond the price levels of similar companies in their sector. The primary motive is to make shares seem more affordable to small investors even though the underlying value of the company has not changed.

A stock split can also result in a stock price increase following the decrease immediately after the split. Since many small investors think the stock is now more affordable and buy the stock, they end up boosting demand and drive up prices. Another reason for the price increase is that a stock split provides a signal to the market that the company's share price has been increasing and people assume this growth will continue in the future, and again, lift demand and prices.

Another version of a stock split is the reverse split. This procedure is typically used by companies with low share prices that would like to increase these prices to either gain more respectability in the market or to prevent the company from being delisted (many stock exchanges will delist stocks if they fall below a certain price per share). For example, in a reverse 5-for-1 split, 10 million outstanding shares at 50 cents each would now become two million shares outstanding at $2.50 per share. In both cases, the company is worth $50 million.

The bottom line is a stock split is used primarily by companies that have seen their share prices increase substantially and although the number of outstanding shares increases and price per share decreases, the market capitalization (and the value of the company) does not change. As a result, stock splits help make shares more affordable to small investors and provides greater marketability and liquidity in the market.

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Investopedia.com believes that individuals can excel at managing their financial affairs. As such, we strive to provide free educational content and tools to empower individual investors, including thousands of original and objective articles and tutorials on a wide variety of financial topics.

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

Channel stuffing, also known as trade loading, is an illegal business practice used by companies to blow up their sales and earnings figures. It is the ponzi practice of sending more products through its distribution channel than the distributors/retailers can sell. When the products are shipped from the company, they may be considered as sold and may be used to boost the figures.

Companies can do channel stuffing for various reasons like,
 

• Painting the fundamentals like sales and earnings figures; to get better stock prices and media attention.
• To meet up with competitors' (or its own previous) performances or targets.
• To highlight/paint its performance over a specific channel like international trades or a specific product.
• Poor sales force management can also be a cause; trying to meet-up the long-term target in a short-term.

Channel stuffing can be regarded as a short-term practice with long-term consequences.
 

• As more products are shipped, the distributors tend to return the unsold ones or stop giving further orders; thus the future figures get worse.
• Creating more products for channel stuffing can demand factory overtimes, and returning unsold products or lack of orders can result in factory shutdowns.
• The fundamentals can become less and less attractive and can adversely affect stock prices.
• The marketing and selling of products become more and more complex and unmanageable.

Many companies regardless of their size have been identified and criticized for their channel stuffing activities. In the U.S., the Securities and Exchange Commission has litigated some companies for these activities.
 

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What does this chart from the U.S. Energy Information Administration (EIA) tell you?

Exactly. There has been a dramatic decline in U.S. oil production.

The amount of crude oil produced per day per well went up in the 1960s. It reached a peak of 18.6 barrels per day per well in 1972. After 1972, productivity generally declined. The 2008 rate of 9.4 barrels per day per well was 49% below the peak – the lowest since the EIA began reporting oil well productivity.

Now, what does this chart tell you?

Right again. World crude oil production has basically flat-lined since 2005. And production is not going to increase anytime soon. Consider the words of Andrew Hall. (He’s the Chairman of Phibro LLC and a phenomenally successful oil trader.) He recently said that “oil production in many parts of the world has already peaked and entered a terminal decline.”

What About New Discoveries?

It’s true. Oil companies have found new sources. Last September, BP announced a giant oil discovery in the Gulf of Mexico. Estimated size? 3 billion barrels. Woohoo! The problem is, the field is six miles beneath the surface of the Gulf. So, like many new sources, it’s going to be expensive to get to it. And only 500 million barrels are recoverable with today’s technology.

To put this discovery in perspective, 500 million barrels would supply the world for a scant six days. In the end, this new oil will simply offset diminished production in existing oilfields.

Whether or not the world is running out of oil is open to debate. But, it most assuredly is running out of cheap oil.

Demand

According to the EIA, the world oil market should gradually tighten in 2010 and 2011. Demand will begin to grow again as the global economic recovery continues.

So now let me ask you to look at another chart.

World Population Growth

We’re in the midst of a population explosion. The world’s population cur­rently stands at 6.6 billion. We are projected to reach 7 billion by 2012 and 8 bil­lion by 2025. An undeniable long-term trend.

Will 1.4 billion more people on the planet in the next 15 years create any additional demand for energy?

What does this final chart tell you?

Yup. There’s no way to stop it. Global energy demand is rising.

And despite the U.S.’s EIA saying that nuclear energy consumption in America could increase from 8 quadrillion BTU to 16 quadrillion BTU by 2030,  the world will still be dependent on oil for years to come.

Where to Invest

There are many ways to profit from this trend. One option is to invest in energy ETFs – and there are lots to choose from. Or you could invest in the large vertically integrated oil companies. That gives you exposure to oil and natural gas as well as to refining and distribution.

If you’re looking for more upside, try investing in the small and medium-sized oil exploration and development companies. To expand their reserves, the bigger companies will be swallowing many of them up in the next year or two.

It’s really simple. All you need to know about oil is that supply is flat and declining. And demand is increasing. For more specific energy investments, see Sound Profits.

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Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.