All the news in stock markets has focused on record high inflation, interest rate hikes from the US Federal Reserve, and just generally dour economic news.
But the stock markets, while falling, continue to allow us to buy into real-life businesses. One aspect of stock markets, which I’ve found interesting of late, is the phenomenon of “stock splits”.
This is where companies essentially issue no new shares but split their stock so that their stock price is lower than it originally was.
Multiple examples abound over the past few years. For example, Tesla Inc (NASDAQ: TSLA) split its stock 5-for-1 in August 2020 and just last week proposed a new 3-for-1 split.
Meanwhile, other notable stock splits that have been in the news recently include Amazon.com Inc (NASDAQ: AMZN) and Alphabet Inc (NASDAQ: GOOGL).
So, for investors, what does it all mean? And does it benefit shareholders in any way? Here’s what you should know on stock splits.
Same size cake but more slices
Effectively, a stock split just takes the existing share float and slices it up into more shares so that the resultant stock price is lower.
While you may have had 10 Tesla shares prior to its stock split in 2020, the fact that you then had 50 Tesla shares post-the-split didn’t make you any richer.
That’s because while those 10 shares turned into 50 shares, the value of Tesla’s share price also came down to one-fifth of what it was prior to the split.
At the end of the day, shareholders are no worse, or better, off in terms of their actual stock holdings and their collective value.
Higher liquidity with lower share price
Companies and their management teams, however, remain cognisant of the fact that a lower share price lends itself to higher trading liquidity in the stock.
That tends to benefit share price action. While many investors in the US are able to access fractional share trading, many international investors buying into US stock markets may not enjoy that same privilege.
As a result, buying Amazon at US$3,000 a share last year (prior to its 20-for-1 stock split) becomes a lot less palatable than picking up its shares for around US$100 a pop today.
Granted, Amazon’s share price has fallen since its stock split was announced but so has the broader market.
Short-term boost to the share price?
Interestingly enough, research has found that companies that announce stock splits do see strong outperformance in the short term (see below).
That may be down to a number of factors such as increased liquidity, better awareness among retail investors and a generally positive view of the act of splitting stock itself.
One other reason companies like to carry out stock splits is down to stock-based compensation. Including stock awards in remuneration packages is common but for stocks trading in the thousands of dollars, awarding fractional stocks isn’t possible.
With a lower share price, there’s a lot more flexibility as it relates to stock compensation awards for lower-paid workers – such as Amazon warehouse employees.
No downside but upside potential exists
For companies that do split their stock, there really isn’t a downside for shareholders. If anything, it increases the available pool of investors that can access the stock.
That in turn will help trading liquidity, which is a key reason for the short-term outperformance mentioned above.
However, it is important to note that in a bear market – such as the one we’re currently in – those share price “pops” that were common on stock-split announcements in 2020 and 2021, may disappear.
At the end of the day, though, investors who hold a company that’s splitting its stock should view it as a positive move.
Disclaimer: ProsperUs Head of Content & Investment Lead Tim Phillips doesn’t own shares of any companies mentioned.
