Stock Splits
“You better cut the pizza in four pieces because I’m not hungry enough to eat six.” – Yogi Berra
Imagine a situation where you receive a manufacturer’s notice that states that for every one of their products you own, they will send you three more for free. What’s the catch, right? In the case of stock splits, the company is effectively increasing the number of slices without changing the composition of the entire pie. Apple and Tesla recently announced stock splits which brought to light a practice that has been declining in popularity over the last two decades. Why does a company split? Is it a good or a bad thing?
From a purely mathematical standpoint, a stock split has no effect on the general pool of equity. If you make change for a $20 bill into twenty singles, you still have the same amount of money, just in a smaller incremental amount. Remember, a share of a stock is a small piece of the ownership of a company. Increasing the amount of shares just dilutes each share’s ownership stake in the company. If you are currently receiving a dollar in dividends from Apple for one share, you will now receive four dividends of $0.25 (not the real numbers, but we like easy math here).
That being said, splitting shares has an emotional and practical effect on the potential buyers of a given stock. Berkshire Hathaway’s “A shares” have famously never split and the share price has ballooned to a whopping $320,000/share. This is an extreme example but think about how unwieldy that would be in an investor’s portfolio who needs to raise cash or rebalance. Granted, it’s one of those good problems to have, but it also presents problems for potential buyers without “new house money” on hand. Stock splits solve this problem. From Apple’s Investor Relations department: “We want Apple stock to be more accessible to a broader base of investors.” Emotionally, people feel like they are getting a better deal by buying at a lower price. Practically, they can simply afford it more easily when the price is lower.
When a company needs to raise cash, they either turn to creditors in the form of banks or bonds or they turn to the equity markets and issue more shares. It’s important to understand the difference between share issuance and a stock split. The former dilutes the ownership percentage of current owners while the latter does not. From my perspective, Apple’s decision feels more cosmetic while Tesla’s decision could have some operational functionality. In its current form, Apple has no problem accessing cash and frankly does not have a large need at the moment given the enormity of cash on its balance sheet. Tesla, on the other hand, will probably need cash for a variety of reasons at some point in the future and increasing the pool of potential investors by lowering their share price can only help their prospects if/when they decide to issue more shares.
The advent of ETFs and, more recently, direct access to fractional shares is correlated with a declining popularity in stock splits. ETFs allow for cheap access to a basket of stocks and a more passive style of investing. An investor in the S&P 500 ETF gets a small piece of those big companies without having to worry about the underlying share price. There are still those out there who like to buy individual shares and a stock split is designed to cater to those investors.