Split Accounting

Some market participants try to make money off of stock splits, expecting the supply or demand of shares to rise or fall following splits or reverse splits. On the other hand, value investors recognize that the intrinsic value of the company has not changed post-split, and therefore stock splits are considered irrelevant events. Unfortunately, however, splits can complicate one's valuation of a company; accounting for splits is not just a matter of adjusting the number of shares outstanding and the price per share. Recent splits can cause valuations to go haywire if not properly accounted for.

Last week, we discussed a company called NovaMed (NOVA), which operates surgery centres throughout the United States. Thanks to reader Jay for pointing out that a recent reverse split changes the conversion price of the company's convertible debt to an amount that materially changes their value.

The most recent quarterly report (dated May 10), lists the conversion price at $6.31 (ignoring the warrant sales/purchases which effectively alter the conversion price), which is lower than the current stock price of $8.00. But fifteen days later (May 25th), the company approved a reverse 1:3 stock split and a month later the reverse split took place, which changed the conversion price to almost $19.00 (if it is to be compared to the current stock price), reducing the chances of dilution considerably.

Don't do what I did in assuming the quarterly report has the most up to date information. You don’t need to be studying in the best online MBA programs to know this is common sense. Stock splits and reverse splits since a company's last report can falsely skew a valuation. Investors should ensure they are up to date on a company's most recent filings before concluding their valuations.

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