Yesterday marked the first day Apple and Tesla, two company names that have dominated headlines and market indices, began trading post-stock split. So, what is a stock split, and what does it mean for investors?
Importantly, a stock split does not fundamentally change the value of a company. When we talk about a company’s size, we measure it in terms of its market capitalization, the number of its shares outstanding multiplied by the price of one share. When a company issues a stock split, the number of shares outstanding is multiplied and the price of each share is divided, leaving us with the same overall market capitalization. Put another way, a stock split is like the company coming in and paying you, the investor, 4 quarters in exchange for a dollar bill.
Take Apple for instance, which just issued a 4-to-1 stock split. An investor who previously held 10 shares of Apple at $500 each had a total investment of $5,000 in Apple. Post-split, she now holds 40 shares of Apple, each worth $125. While the number of shares has quadrupled, the price of each share has gone down to reflect the same underlying value of the company.
So, why might a company issue a stock split? A common reason is to entice investors who might have found the $500 per share price prohibitively expensive. An investor who cannot afford to purchase Apple at a sticker price of $500 may now be able to purchase one or two shares at $125 each.
While this reasoning may have made these companies more accessible in the past, stock splits these days are usually more about the attention-grabbing headline. That’s because over the last few years, many brokerage firms have allowed the purchase of fractional shares, or “slices” of stocks, allowing investors to buy into companies by purchasing shares at a dollar amount rather than a number of shares. In other words, nowadays, if $500 a share is too pricey for a particular investor, that investor has the option to go to a brokerage firm and purchase one-tenth, one-fifth, one-quarter, etc. of that share, at a proportional fraction of the cost. The whole unit price is broken down so that even the smallest of investors can participate.
So why the hype? Stock splits can generate a buzz around the future of a company’s price. Investors may think they can use the split as an opportunity to “buy low, sell high.” But remember, the lower price has nothing to do with the intrinsic value of the company in question, and the stock price is just as likely to go up as it is to go down following a stock split.