FINANCE TODAY | ISSUE NO.10
THE FIVE W'S OF STOCK SPLITS
A stock split is when a company divides existing shares into multiple new shares to increase the stock’s liquidity. In other words, a single share is “split” into numerous shares of lesser financial value. For example, when Apple issued a 4-for-1 stock split, an investor who had 10 Apple shares valued at $200 CAD per share before the split, would have 40 shares valued at $50 CAD each, both with a total value of $2,000 CAD. This illustrates how existing investors and the company do not gain or lose anything, but the individual stock price is reduced. The reason why some companies split their stocks is to increase the availability of shares to retail investors, who may not have been able to afford to invest in the company otherwise. From a behavioural finance approach, another possible explanation for a stock-split is that it acts as a signal that the company is confident it will be able to deliver future earnings that do not decline. This also ties into the “when” question of stock splits, since companies generally split their shares when the prices are too high, or they are optimistic about future growth.
THE PAST AND PRESENT
Monday, August 31 marked the day that both Apple and Tesla stocks began trading on a split-adjusted basis, with both stocks closing at record high by the end of the trading day. Shares of Apple rose 3.3% while Tesla shares rallied a whopping 12.5% (Udland, 2020). Historically, Apple’s stock prices have fallen following a stock split. After each of Apple’s four previous stock splits, the share price fell over the next 10 trading days (Udland, 2020). Generally, splits do not elicit much of a response from investors, however, at times they can spark rallies of their own, which was illustrated by Apple and Tesla over the past few weeks. The dot-com boom of the 1990s also saw a frenzy of stock splits, with Amazon, Sony, and General Electric all splitting their stocks multiple times over the course of the decade. Interestingly, what today’s era has in common with the dot-com boom is that these splits are being spurred by retail investors. “Mom and Pop” retail investors made up a new class of investors in the late 90s when online brokerages began to democratize stock trading to make it more accessible (Bieber, 2020). 2020 is no different, with the number of retail investors spiking by 35% during the COVID-19 pandemic, and the recent abundance of online investing platforms (Bowman, 2020). The stocks that split during the dot-com boom performed at varying degrees of success, but all notably increased following their stock splits, as illustrated below.
The top graph shows Tesla stock’s closing price between August 2019 and September 2020. The bottom graph shows Apple stock’s performance following the company’s first stock split in June of 1987. The blue bar shows the immediate date of the stock split. As can be seen the stock price rallies and then falls in the longer term.
There is no doubt that both Tesla and Apple believe, or want investors to believe, that their companies will continue to be profitable and that share prices will continue to rise. However, some analysts are skeptical and reckon that stock price increases are not inevitable. Forbes claims that Tesla’s stock split does not signal that its shares are fairly priced relative to the fundamentals of the business, and says that the stock’s market value still currently lies above its fundamental value and is overvalued (Shefrin, 2020). Post stock split, the range of target prices for analysts covering Tesla was between $17.40 to $500 USD, while the actual closing price on August 31 was $498 USD (Shefrin, 2020). Forbes warns that investors should not get caught up in the media attention the companies garner from a split and should consider the psychological signals the companies are trying to send before investing. Choosing to invest in Apple, Tesla, or any company post-stock split, investors must also consider their investing goals. Short-term investors can often profit more from these events than long-term investors. According to investment platform eToro, after evaluating 60 years of data, it was found that share prices rise an average of 33% in the year following the split (Bieber, 2020). There are numerous reasons for this phenomenon, one being that shares are cheaper and more retail investors can afford them. Another is that when large, popular companies split their stocks, it generates a lot of media attention which can drive up demand and increase share prices. However, a common point of agreement is that there is one thing missing from the list of reasons why splits help increase share prices which is necessary for long-term success: a fundamental change in company value. An example would be a state-of-the-art innovative technology or a new product that fundamentally changes the value of a company, which a stock split is not. That is why short-term investors can profit from the split hype, while long-term investors rarely gain from the small blip caused by stock splits.
The stock market is an exciting, fast-paced environment where you can either gain off your investments or squander them all within a matter of minutes. The Apple and Tesla stock splits are very interesting opportunities for smaller retail investors to purchase shares, and for shorter-term investors to potentially earn large profits. Apple and Tesla will try to entice more investors with their lower prices, but it is important to remember your investing goals and understand the fact that stock splits ultimately do not add any value to the company.
Bieber, Christy. “The Apple and Tesla Stock Split Game Is for Short-Term Investors Only.” The Motley Fool, The Motley Fool, 1 Sept. 2020, www.fool.com/investing/2020/09/01/apple-tesla-stock-split-game-is-for-investors/.
Bowman, Jeremy. “Stock Split Fever for Apple and Tesla Could Be a Warning Sign.” The Motley Fool, The Motley Fool, 3 Sept. 2020, www.fool.com/investing/2020/09/03/apple-tesla-stock-split-fever-could-be-warning/.
Shefrin, Hersh. “What Tesla’s Stock Split Does And Does Not Signal.” Forbes, Forbes Magazine, 1 Sept. 2020, www.forbes.com/sites/hershshefrin/2020/08/31/what-teslas-stock-split-does-and-does-not-signal/.
Udland, Myles. “Why Apple and Tesla Shares Surged after Getting Split: Morning Brief.” Yahoo! Finance, Yahoo!, 1 Sept. 2020, finance.yahoo.com/news/apple-tesla-stock-split-more-shares-to-go-around-morning-brief-100905716.html.