Stock splits from Tesla and Apple have had a significant
impact on recent business news, from all time high valuations, the pouring in
of investors and boosts to personal wealth.
But for the everyday investor it is not immediately obvious what a stock split is, why they are done and if they really matter.
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| Photo by Tech Daily on Unsplash |
Unlike some other corporate actions that have vague or unintuitive names, a stock split is indeed the splitting of stock. Another distinguishing feature is that this is an instance where a company intentionally lowers their stock price.
A stock split is when a company chooses to divide existing shares that are deemed high value into a larger number of lower value ones. The decision to split stock is not made by the exchange or any external regulator, it is solely the decision of the company.
If you have £1000 free to invest and the shares cost £600 each then you can only buy a single unit; if the company performed a 2-1 split making the share price £300, and now you can have 3 shares on the same budget. The increase in the volume of shares being purchased is felt as an increase in demand, even when the total value being traded remains the same.
Why do companies do it?
A common misconception is that a company will perform a stock split as part of a fundraising initiative – in actual fact a stock split does not raise money. The action provides a higher quantity of shares in the market at a lower price which results in a net neutral outcome to any existing shareholder regarding dilution.
For illustration let us say that a company has a market capitalisation of £100 represented by 100 shares at £1 each. Following a 2 – 1 stock split there would be 200 shares at 50p each – making each share cheaper to purchase but leaving the market capitalisation at £100.
Since it first listed in 1980 Apple Inc has split its stock 5 times – 3 times at 2-1, once a 7-1 and most recently at 4-1 meaning that your single share at 1980 (purchased for $22) would now be 224 shares. In other words if Apple had never split its stock it would cost in excess of $22,000 per share and would likely be out of reach for many investors to directly hold equity in Apple.
Berkshire Hathaway A Class shares are trading in excess of $300,000 in no small part to never splitting their stock and retaining all of their earnings. It is rare situations such as these that proponents of stock splitting would state their case – Berkshire’s business involves a lot of M&A, and the possibility of an all share buyout can be greatly hindered by such large values on individual shares. If Berkshire wanted to buy a company using just shares for $1m, it would not be possible. At the very least a combination of cash and shares would be required and it just so happens that Berkshire still has a remarkable pile of cash and equivalents burning a hole in its pocket.
How do they affect existing investors?
On the surface it seems to be the case of six and two threes, but there are subtle effects on the investor. One of the ways it does impact a shareholder is with an investors best friend – compounding. Take the following (albeit extreme) example:
1 share valued at £1000 yielding £50 per annum means you would need to accrue 20 years of dividends in order to have a £2000 holding.
1000 shares at £1 each yielding £0.05 per annum reinvested, means in the same period you would have near enough £2600, a significant boost by any measure.
The example is taken to an unrealistic extent for the purpose of illustration but hopefully highlights that a long term holder or shares, who chooses to re-invest the dividends can realise some advantage in owning shares that are split when appropriate.
So what is going on with Apple and Tesla?
Both Apple and Tesla’s stock prices reacted positively to the most recent stock splits, with both companies reaching record highs in the weeks after announcing the planned stock spilt. It is important to highlight that the stock splits are not driving up the price, rather it is the investor sentiment bidding up the price in response to a stock split.
The mere news that a company plans a stock split draws in the media attention, which in often tends to drum up extra demand. Technology companies are enjoying an additional boost during the pandemic, but the stock split and subsequent rise in price does not equate to a rise in intrinsic value.
Remember past performance isn’t a guide to the future.
This article is not advice and has not been prepared in accordance with legal requirements designed to promote the independence of investment research – no recommendations are given in the buying, selling or holding of any investments. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.