A Guide to Understanding Stock Splits

Big Day for Stock Splits

This morning, two of the most high-profile companies in the world, Apple and Tesla, split their stocks. Shareholders of Apple (Ticker: AAPL) received four shares of “new” Apple for each share they owned at the close on Friday.  Shareholders of Tesla (Ticker: TSLA) received five shares of “new” Tesla stock for every share they owned on Friday.  The share prices have been reduced by the same proportions.  AAPL closed on Friday at $499 per share so it opened for trading today at about $125 per share.  TSLA closed at $2,213 on Friday so it opened on Monday at about $442.  The dollar value of investors’ holdings does not change as splits are done, just as the amount of pizza you have does not change if your pie is cut into eight pieces instead of four.

Should Investors Care About Stock Splits?

The putative reason that companies split their stocks is to make their individual shares more “accessible” to a wider range of investors, therefore presumably increasing the pool of potential buyers along with deepening trading liquidity.  The market capitalization of a company does not change when its stock splits.  In a 2-for-1 split, for example, a company doubles the number of shares outstanding but halves the per-share price.  Thus, the split itself does not do anything mechanical to increase the company’s market capitalization.  However, there is evidence that a stock split engenders increased investor confidence and goodwill, and it often precipitates increased trading in a stock before and after the split.  There is also a perception among some investors that a stock is somehow “cheaper” after a split and therefore more desirable.

There are a number of studies on the effects of stock splits that show that companies that split their shares, on average, have outperformed those that do not.  If you think about it, this is logical.  Companies that do stock splits have normally enjoyed significant stock price appreciation.  (If you are doing a 4-for-1 split, something good has probably happened to your stock recently.  If your stock has been stuck at $30 for five years, there is not much reason to do a split.)  Companies that have done many stock splits are an elite and very successful group, so it stands to reason that they have, as a group, outperformed the broader market.  But, in our view, their stocks have outperformed because their businesses grew rapidly and successfully, not because they engaged in any stock splits.

Our View

At Orion, we are indifferent as to whether companies split their stocks or not.  Ultimately stocks trade around the fundamentals of growth in revenues, dividends and profits.  Whether there are more or fewer shares outstanding does not affect these business metrics or the company’s market capitalization.  While stock splits can augur a temporary bullish sentiment for investors, they do not, in and of themselves, make stocks perform over the longer term.  It is the companies themselves that, by generating strong business performance, make their stocks go up.  Strongly performing companies are likely to see their share prices increase, with or without stock splits. 

This piece is for informational purposes only and is not a recommendation to buy or sell any security. Individuals should consult their own advisors for investment advice.

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