5 Sep 2020 | Eugene Ng | Founder & CIO | Vision Capital
What happened recently?
There has been some excitement in the stock market recently, as both Apple and Tesla have just split their stock — 4-for-1 and 5-for-1, respectively.
This excitement is not warranted in our opinion, though, because stock splits are far less meaningful than one might think.
And don’t believe everything you read in the media about the companies and the splits, with anyone suggesting that the shares will surge higher post-split.
What is a Stock split?
A stock split is a corporate action in which a company increases the number of its outstanding shares by issuing more shares to current shareholders.
The primary and only motive of a stock split is to make shares seem more affordable to small investors.
See what Apple and Tesla’s investor relations had to say:
We want Apple stock to be more accessible to a broader base of investors.
Although the number of outstanding shares increases and the price per share decreases, the market capitalisation (and the value of the company) does not change.
The most common split ratios are 2-for-1 or 3-for-1, which means that the stockholder will have two or three shares, respectively, for every share held earlier.
Reverse stock splits are when a company divides, instead of multiplies, the number of shares that stockholders own (thereby raising the market price of each share). Correspondingly the number of outstanding shares decreases and the price per share increases, again the market capitalisation (and the value of the company) does not change.
How do stock splits work?
Before we jump into an example, there are three key dates one needs to know:
- The Record Date — when shareholders are entitled to receive additional shares due to the split.
- The Split Date — when shareholders are due split shares after the close of business on this date.
- The Ex Date — when the shares will trade at the new split-adjusted price.
Let’s take Apple’s recent 4-for-1 stock split for example. A 4-for-1 split means that three additional shares of stock are issued for each share in existence on the Record Date of August 24, 2020.
Investor initially owns 100 shares @ $400 = $40,000
Here’s an example: Let’s assume that as of the Record Date (August 24, 2020) an investor owns 100 shares of Apple common stock and that the market price of Apple stock is $400 per share, so that the investment in Apple is worth $40,000.
After Split, Investor now owns 400 shares @ $100 = $40,000
Let’s also assume that Apple’s stock price doesn’t move up or down between the Record Date and the time the split actually takes place. Immediately after the split, the investor would own 400 shares of Apple stock (instead of a 100), but the market price would be $100 per share instead of $400 per share.
The total investment value of $40,000 remains unchanged
The investor’s total investment value in Apple would remain the same at $40,000 until the stock price moves up or down.
Why don’t we trade stock splits?
Stock splits create no economic benefits other than making the stock cheaper. We do not trade, we invest long-term and see absolutely no value in doing so.
Why do we love Stock Splits?
Stock splits are usually a good sign that the companies have done well thus far over the long-term. This is usually evidenced by rising underlying business performance, revenues, profits, cashflows and accompanied by eventual rising stock prices. And the company would like to reduce its stock price so more people can buy and invest in the company.
Take Apple for example. This is their fifth stock split since going public, and had done so back in 1987, 2000, 2005 and 2014 previously.
Reverse stock splits on the other end, we tend to be much more cautious as it is usually the reverse. Because usually the company is not doing well, and thus accordingly the stock price is declining rapidly. Thus in such a scenario when a company does a reverse stock split, it is usually to make its stock price higher.
Why then the hype?
Does owning more shares make a difference? Maybe psychologically there is. One feels like they are owning more. But if you are owning more at a lower price, such that your total value of your holdings economically remains the same, there is no difference to us and to anyone.
In Summary
Do not get trapped by sensationalised media headlines such as this ”….will surge 33% post the stock split…” and trigger an emotion and an immediate corresponding action to buy the stock.
Stock prices generally often rise and continue to rise for well-run companies that are doing well growing revenues, profits and cash flows, not because of stock splits.
Invest in a stock for the long-run because the business is doing well and will continue to do well, not because of a short-sighted single event that is irrelevant in the grandest scheme of things.
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