Stock Splits: More Accessible, Not Cheaper
When Apple and Tesla announced their stock split, it was interesting to me to see the clear excitement from individual investors. After all, splitting stocks is the same as slicing a pizza into more pieces.
Back in my university days, from time to time, I shared pizzas with three other friends. We would split a $20 pizza in four equal sections for five bucks a slice. Then one day, I wanted to cut down on my pizza-related expenses, so I asked that we slice up the pizza in eight pieces instead of the usual four pieces. I would pay half the price, $2.50, for one smaller slice. This option made sense to me because I still wanted to eat pizza, but not as much. Those that paid the usual $5.00 still got a quarter of the pizza, but instead of one large piece, their serving was the two small pieces. On August 31st, Apple split its stock 4-for-1 and Tesla did a 5-for-1 stock split. What does this mean? From a fundamental perspective, not much. Some analysts describe a stock split as a “financial non-event” in the sense that it does not change the companies’ outlook and value. A stock-split is the equivalent of cutting a pizza in more slices so that each individual slice will be sold at a lower price. The pizza is still the same sized $20-dollar pizza, it’s just cut in smaller pieces. The stock-split did not change the size of the companies or their financial outlook. It increased the amount of stocks in circulation, making each individual stock more affordable. Keep in mind that each individual share following a split represents a smaller percentage of ownership, which is why the price is lower. Although this might be a “financial non-event”, some people reacted strongly to the news based on what I’ve seen on social media. First, some Tesla shareholders panicked, thinking the share value had dropped by 80%.Theshareholder only looked at the lower share price and did not realize that he now had more Tesla shares in his portfolio. For every share owned before the split, he received an additional four shares. So, if he owned one share, with the additional shares received, he now owns five shares, which is why they call it a 5-for-1 split. Another emotional reaction seen online was the excitement of lower prices as a great buying opportunity, confusing the lower price as a result of the stock split with a “buy-low” opportunity. It’s important to understand that the lower stock price on August 31st was not due to a market correction that is often seen as a buying opportunity. It was simply mathematical. Because there are more stocks in circulation following the split, the stock price will be lower. For example, let’s assume a company with a market capitalization of $1 billion has 10 million stocks in circulation, the price of each share would be $100. If that company executes a 4-for-1 stock split, there will now be 40 million stocks in circulation, but the company’s market capitalization has not changed. So, the price of each share will be $25. To summarize, a stock split will make an individual share more affordable. But it is not a bargain or a “buy-low” opportunity. Your decision to invest in a company should not be based solely on a stock split, but rather on elements such as its financials, strength of management, potential for growth and capacity to generate income. If you do not like a company as an investment option, a stock-split should not change your mind. Originally published September 12, 2020 This writing is for general information purposes only and is not intended to provide legal, accounting, tax or personalized financial advice. For complex matters you should always seek help from a professional. Any opinions expressed are my own and may not reflect those of Louisbourg Investments. Author:
Marc André Castonguay, CFP®, CIM® is a financial planning manager with Louisbourg Investments. Comments or questions may be submitted to him at firstname.lastname@example.org.