The adjusted closing price is a critical metric in stock analysis, as it accounts for corporate actions that affect a stock’s value. It is essential for examining historical returns and analyzing past performance.
**Key Takeaways:**
– The adjusted closing price reflects a stock’s value after accounting for corporate actions.
– The raw closing price is the cash value of the last transacted price before the market closes.
– Corporate actions such as stock splits, dividends, and rights offerings are factored into the adjusted closing price.
– The adjusted closing price provides a more accurate representation of a firm’s equity value over time.
**Understanding the Adjusted Closing Price:**
Stock values are expressed in terms of both the closing price and the adjusted closing price. The closing price is the raw price, representing the cash value of the last transaction before the market closes. The adjusted closing price incorporates any changes that might affect the stock price after the market closes.
A stock’s price is influenced by market supply and demand. However, corporate actions like stock splits, dividends, and rights offerings can alter a stock’s price. Adjustments are necessary for investors to have an accurate record of the stock’s performance. Understanding how corporate actions are accounted for in a stock’s adjusted closing price is crucial, especially when analyzing historical returns.
**Types of Adjustments:**
**Adjusting Prices for Stock Splits:**
A stock split is a corporate action aimed at making shares more affordable for average investors. It does not change the company’s total market capitalization but does affect the stock price.
For instance, if a company’s board of directors decides on a 3-for-1 stock split, the number of shares outstanding increases threefold, while the share price is divided by three. If a stock closed at $300 the day before the split, the adjusted closing price would be $100 per share ($300 divided by 3) to maintain a consistent standard of comparison. All previous closing prices for that company would similarly be divided by three to obtain the adjusted closing prices.
**Adjusting for Dividends:**
Common distributions that affect a stock’s price include cash dividends and stock dividends. Cash dividends entitle shareholders to a predetermined price per share, while stock dividends grant additional shares.
For example, if a company declares a $1 cash dividend and was trading at $51 per share before the dividend, the stock price would fall to $50, as that $1 per share is no longer part of the company’s assets. However, dividends remain part of the investor’s returns.
Adjusted closing prices in the stock market are crucial for accurately reflecting a stock’s performance over time. By accounting for dividends and rights offerings, these prices provide a clearer picture of returns.
Firstly, adjusted closing prices are obtained by subtracting dividends from previous stock prices. This adjustment is essential as it reflects the actual returns an investor would have received from their investment. Secondly, rights offerings are also considered in the calculation of adjusted closing prices. Rights offerings are issues of rights given to existing shareholders, allowing them to subscribe to additional shares in proportion to their current holdings. This can lead to a decrease in the value of existing shares due to the increased supply. For instance, if a company declares a rights offering where shareholders can purchase an additional share for every two owned at a subscription price, the adjusted closing price is calculated based on this factor. The benefits of adjusted closing prices are manifold. They facilitate the evaluation of stock performance by helping investors understand potential returns on their investments. Adjusted prices are particularly useful when comparing the performance of different assets, as they account for stock splits and dividends, which can otherwise skew the performance data. Critics argue that adjusted closing prices can sometimes obscure useful information contained in nominal closing prices. For speculators, key price levels can be significant, and the tug of war between bulls and bears at these levels can lead to breakouts or breakdowns in asset prices. Adjusted closing prices may hide these events, making it harder to understand contemporary market dynamics. Investors can gain valuable insights by examining the actual closing prices at the time, which can help them understand what was happening in the market and interpret historical records more accurately.The Dow Jones Industrial Average (DJIA) is a prime example of the influence of nominal prices on stock market behavior. Perhaps the most famous instance is the role that Dow 1,000 played in the 1966 to 1982 secular bear market. During that period, the DJIA repeatedly hit 1,000, only to fall back shortly after that. The breakout finally took place in 1982, and the Dow never dropped below 1,000 again.
This phenomenon is somewhat obscured when dividends are added to obtain the adjusted closing prices. In general, adjusted closing prices are less useful for more speculative stocks.
Jesse Livermore provided an excellent account of the impact of key nominal prices, such as $100 and $300, on Anaconda Copper in the early 20th century. In the early 21st century, similar patterns occurred with Netflix (NFLX) and Tesla (TSLA).
William J. O’Neil gave examples where stock splits, far from being irrelevant, marked the beginnings of real declines in the stock price.
While arguably irrational, the impact of nominal prices on stocks could be an example of a self-fulfilling prophecy. These psychological barriers can significantly influence investor behavior and market trends.