Why companies like Amazon and Tesla opt for a stock split
Over the past few years, industry headlines have been filled with the news that big tech powerhouses such as Apple, Amazon, Google parent company Alphabet, and Tesla have announced their plans to participate in a stock split.
But what actually is a stock split?
The name itself seems pretty self-explanatory, however, for a new investor, it can be more complex than it appears.
What are stock splits?
Breaking expensive stocks down into smaller pieces, a stock split makes highly sought-after stocks more affordable and attractive to a wider range of investors.
While it's generally great news when a stock price goes up, sometimes they can become so valuable that it's difficult for some investors to get a foot in the door.
That's when a company might decide to do a stock split.
How do stock splits benefit investors?
You could argue that splits are simply psychological, by making valuable stocks seem more within reach of smaller retail investors. A stock priced at USD$440 is generally more attractive to retail investors than a stock priced at USD$2200.
Stock splits might change the stock price, but they change nothing about the fundamentals of a stock. It has the same price-to-earnings (P/E) valuation and the same earnings per market capitalisation (market cap).
That said, a stock split tends to bode well for stock prices. Fractional share trading is now an important part of investing, but the price of a stock can still play a huge factor. Investors will often feel that a stock with a lower share price has more growth potential than one with a higher price.
For many investors, a stock split simplifies portfolio rebalancing. When each stock now involves a smaller percentage of an overall portfolio, it's much less complex to rebalance that portfolio.
How do stock splits benefit companies?
Historically, stock splits have been bullish for companies. Investors view stock splits as a sign of confidence by management.
Since 1980, S&P 500 companies announcing stock splits have returned an average of 25.4% over the following 12 months. In comparison, the S&P 500's average return was only 9.1% over the same period.
Even talk of a stock split can benefit companies and investors. Before the market opened on Monday, March 28, 2022, Tesla announced its intention to undertake a second stock split later in the year (the first was in August 2020). By Friday's close, Tesla's stock was up 8.8% on the Monday close - compared to only a 3.2% increase in the Nasdaq and 1.9% for the S&P 500.
It was a similar story when Amazon and Google's parent company Alphabet announced their latest stock split plans earlier in the year.
Stock splits also improve liquidity. If a stock's price skyrockets, it tends to reduce the stock's investing volume.
Increasing the number of outstanding shares at a lower per-share price adds liquidity. This tends to narrow the spread between the bid and ask prices, enabling investors to get better prices.
How do stock splits play out in the long run?
We analysed 60 years' worth of data and found that, on average, companies saw their share prices rocket by more than 33% in the 12 months after a stock split.
As part of the analysis, we focused on the share price movements of the 10 biggest global brands that have carried out a stock split: Apple, Alphabet, Microsoft, Amazon, Coca-Cola, Disney, Samsung, McDonald's, Toyota and Intel.
Despite the positive price action for stocks after splitting, stock splits are uncommon. The number of stocks electing to split has declined considerably in recent years. Only 28 stock splits have occurred in the S&P 500 over the last five years, compared to 41 across 2006 and 2007.
This decline can reflect an over-emphasis on institutional investors, which overlooks the growing importance of individual retail investors. With more retail investors entering markets in the last two years, during the pandemic, more companies may be exploring options to split their stocks.
Moreover, stock splits help employee ownership, which was one of the many reasons Elon Musk announced Tesla would be splitting its stock back in 2020.
For numerous businesses, equity compensation has been a huge factor in attracting new talent over recent years. A lower price stock makes it easier for employees to join equity programs, plus it makes it easier for employees already who own equity to sell part of their compensation.
In some ways, stock splits can seem like sleight of hand, making stocks seem more attractive even though their fundamentals remain unchanged. Yet it's clear that a stock split can also drive value, by giving investors confidence that they're on a good thing.
Get stories like this in our newsletters.