Adjusted Closing Price: How It Works, Types, Pros & Cons

What Is the Adjusted Closing Price?

The adjusted closing price amends a stock's closing price to reflect that stock's value after accounting for any corporate actions. It is often used when examining historical returns or doing a detailed analysis of past performance.

Understanding the Adjusted Closing Price

Stock values are stated in terms of the closing price and the adjusted closing price. The closing price is the raw price, which is just the cash value of the last transacted price before the market closes. The adjusted closing price factors in anything that might affect the stock price after the market closes.

A stock's price is typically affected by the supply and demand of market participants. However, some corporate actions, such as stock splits, dividends, and rights offerings, affect a stock's price. Adjustments allow investors to obtain an accurate record of the stock's performance. Investors should understand how corporate actions are accounted for in a stock's adjusted closing price. It is especially useful when examining historical returns because it gives analysts an accurate representation of the firm's equity value.

Types of Adjustments

Adjusting Prices for Stock Splits

A stock split is a corporate action intended to make the firm’s shares more affordable for average investors. A stock split does not change a company's total market capitalization, but it does affect the company's stock price.

For example, a company's board of directors may decide to split the company's stock 3-for-1. Therefore, the company's shares outstanding increase by a multiple of three, while its share price is divided by three. Suppose a stock closed at $300 the day before its stock split. In this case, the closing price is adjusted to $100 ($300 divided by 3) per share to maintain a consistent standard of comparison. Similarly, all other previous closing prices for that company would 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. The difference between cash dividends and stock dividends is that shareholders are entitled to a predetermined price per share and additional shares, respectively.

For example, assume a company declared a $1 cash dividend and was trading at $51 per share before then. All other things being equal, the stock price would fall to $50 because that $1 per share is no longer part of the company's assets. However, the dividends are still part of the investor's returns. By subtracting dividends from previous stock prices, we obtain the adjusted closing prices and a better picture of returns.

Adjusting for Rights Offerings

A stock's adjusted closing price also reflects rights offerings that may occur. A rights offering is an issue of rights given to existing shareholders, which entitles the shareholders to subscribe to the rights issue in proportion to their shares. That will lower the value of existing shares because supply increases have a dilutive effect on the existing shares.

For example, assume a company declares a rights offering, in which existing shareholders are entitled to one additional share for every two shares owned. Assume the stock is trading at $50, and existing shareholders can purchase additional shares at a subscription price of $45. After the rights offering, the adjusted closing price is calculated based on the adjusting factor and the closing price.

Benefits of the Adjusted Closing Price

The main advantage of adjusted closing prices is that they make it easier to evaluate stock performance. Firstly, the adjusted closing price helps investors understand how much they would have made by investing in a given asset. Most obviously, a 2-for-1 stock split does not cause investors to lose half their money. Since successful stocks often split repeatedly, graphs of their performance would be hard to interpret without adjusted closing prices.

Secondly, the adjusted closing price allows investors to compare the performance of two or more assets. Aside from the clear issues with stock splits, failing to account for dividends tends to understate the profitability of value stocks and dividend growth stocks. Using the adjusted closing price is also essential when comparing the returns of different asset classes over the long term. For example, the prices of high-yield bonds tend to fall in the long run. That does not mean these bonds are necessarily poor investments. Their high yields offset the losses and more, which can be seen by looking at the adjusted closing prices of high-yield bond funds.

Criticism of the Adjusted Closing Price

The nominal closing price of a stock or other asset can convey useful information. This information is destroyed by converting that price into an adjusted closing price. In actual practice, many speculators place buy and sell orders at certain prices, such as $100. As a result, a sort of tug of war can take place between bulls and bears at these key prices. If the bulls win, a breakout may occur and send the asset price soaring. Similarly, a win for the bears can lead to a breakdown and further losses. The adjusted close stock price obscures these events.

By looking at the actual closing price at the time, investors can get a better idea of what was going on and understand contemporary accounts. If investors look at historical records, they will find many examples of tremendous public interest in nominal levels. Perhaps the most famous is the role that Dow 1,000 played in the 1966 to 1982 secular bear market. During that period, the Dow Jones Industrial Average (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 covered up somewhat by adding dividends 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.