ACCA Advanced Financial Management (AFM) Practice Exam

What does a stock split generally signal about management's outlook?

1. They are unsure about future performance

2. They believe the stock price is too low

3. They are confident about the future

4. They plan to decrease dividend payments

The correct answer is: They are confident about the future

A stock split often signals management's confidence about the company's future. When a company performs a stock split, it divides its existing shares into multiple new shares, which lowers the share price while maintaining the overall market capitalization. This action is usually viewed positively by the market, as it indicates that management believes the company's stock is strong enough to maintain or increase its value after the split. Cutting the share price can also attract more investors by making shares more affordable, thereby increasing liquidity and potentially leading to more demand for the stock. When a company undertakes such a strategy, it often conveys a message of optimism regarding future growth and profitability. This confidence can be reflected in the company's performance and expectations of increasing revenues or earnings. The remaining options point to less favorable interpretations of a company's strategy. For example, expressing uncertainty about future performance or believing the stock price is too low does not align with the proactive nature of a stock split. Similarly, a plan to decrease dividend payments would generally indicate a negative outlook or financial distress, which contradicts the positive intent behind a stock split. Thus, the action of a stock split is closely associated with management’s positive outlook on the future of the company.