Understanding Adjusted Closing Price: Definition, Benefits & Criticisms

What Is the Adjusted Closing Price?

The adjusted closing price is a stock's closing price that's updated to reflect the stock's value after accounting for any corporate actions, such as stock splits and dividends. It's a more accurate reflection of a stock's value. It is often used when examining historical returns to do a detailed analysis of past performance, and to compare the profitability of different assets more effectively. Adjusted closing prices can be useful for long-term investors who wish to determine appropriate asset allocations for their portfolios.

How Adjusted Closing Prices Reflect Stock Value

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 usually changes with supply and demand, but corporate actions like stock splits, dividends, and rights offerings can also impact it. Adjustments allow investors to obtain an accurate record of the stock's performance. Investors should know how corporate actions affect a stock's adjusted closing price, especially when looking at historical returns, for a clear view of the firm's equity value.

Common Adjustments Affecting Adjusted Closing Price

How Stock Splits Influence Adjusted Closing Price

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, if a company splits its stock 3-for-1, the number of shares triples, and the price per share 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.

The Impact of Dividends on Adjusted Closing Price

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. Subtracting dividends from past stock prices helps calculate adjusted closing prices, providing a clearer view of returns.

Rights Offerings and Their Effect on Adjusted Closing Prices

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.

Advantages of Using Adjusted Closing Prices

The main benefit of adjusted closing prices is that they can help when evaluating stock performance, showing investors potential gains from an asset. Importantly, a 2-for-1 stock split doesn't halve an investor's money. Frequent splits in successful stocks would make performance graphs confusing 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.

Limitations of Adjusted Closing Prices

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. Historical records often illustrate public interest in nominal levels, like the Dow 1,000's significance during the 1966-1982 secular bear market. The DJIA often hit 1,000 but fell back until it broke out in 1982, never dropping 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.

The Bottom Line

When sizing up a stock's historical performance, it can be useful to consider both the nominal closing price and the adjusted closing price. Closing prices are adjusted to reflect the potential impact of corporate actions, such as stock splits, dividends, and rights offerings. It's beneficial to use adjusted closing prices to compare the performance of different asset classes over time, as they provides a clearer view of investment returns. However, a downside of adjusted closing prices is that they can obscure useful immediate information conveyed by actual closing prices that traders depend on to determine the strength or weakness of trends and to enter and exit trades.