Are Stock Splits Good or Bad?

Though they’re much more rare than they used to be, stock splits garner a lot of attention on Wall Street. A stock split is when a company increases or decreases the number of shares outstanding. It is often a mechanism used to boost the stock’s liquidity, but there are other reasons which I will touch on later. Stock splits tend to make headlines in the financial industry and for good reason. They are a major event for investors to look forward to, even if the value of the stock doesn’t change. 

What Is a Stock Split?

Are Stock Splits Good or Bad

Wait, what was that last part? The value of the stock doesn’t change? But surely when there are more shares the value does change. It does and it doesn’t. Let’s think of a company as a pizza that is cut into ten slices.

If the company has a 2 for 1 stock split, it means we’d now have twenty slices. But the size of the pizza itself hasn’t changed.

You may own twice as many shares as before, but you’re generally not any wealthier either. 

What stock splits generally do is play with the psychology of investors. Let’s be honest, most investors are greedy by nature. We’re investing money to hopefully make more money. So many investors think of more shares as better.

It’s why we usually see a bullish spike in the stock’s price as buying pressure sets in before the split takes place. But don’t be fooled: the size of the pizza remains the same. 

Is a Stock Split Good?

It’s a question that investors have been asking for decades now: is a stock split good? It depends! Splits can be good for the company. A lower stock price usually allows more investors to be able to buy shares.

They have other positive effects as well. For indices that use price-weighted inclusion like the Dow Jones, a stock split is a way for a company to be added. Apple is a notable company that did this when it executed a 7 for 1 stock split in 2014 and was subsequently added to the Dow Jones in 2015.

Increased liquidity in the stock is good as well. For the most part, companies that execute splits are in good shape. Shares have performed well enough to be at a reasonably high valuation, and the company can afford to see its stock price slashed.

You might naturally think that stock splits dilute the value of the shares. Well if a split makes it cheaper for investors to buy the stock, it also makes it cheaper for the company to buy back its own shares. 

For retail investor sentiment, a stock split is generally a net positive. Allowing more investors to buy the stock is a good thing. Companies like to reward their shareholders, and providing them with more stock is one way they can do it. 

Can a Stock Split Be Bad?

Are Stock Splits Good or Bad
Photo by Ivan Torres on Unsplash

Absolutely. Occasionally you will see a company implement a reverse stock split.

This means that each slice of the pizza is made larger. Think of our ten slice pizza as now being a five slice pizza.

While that’s not necessarily bad when it comes to pizza, when it comes to a stock it can be concerning.

Reverse splits are often utilized by companies that are in distress and want a higher stock price. 

One reason we see reverse stock splits is when a company needs to meet certain price requirements. For example, to avoid being delisted from the NASDAQ index, a stock must trade above $1 per share which is the minimum bid price.

If the stock does not trade over that $1 price level for a certain amount of time, it can get delisted. To avoid this, companies will implement a reverse split to artificially move the stock price back over $1. 

Other companies see a higher stock price as being elite. They believe that the company will be seen in higher standing if the stock price trades higher. Obviously if these companies are concerned with these things, they might not be great businesses to buy in the first place. 

2022: The Year of the Split

We’re only four months into the year and several high profile stock splits have already been announced. With the rise in retail investors getting into the stock market, companies are starting to be more sympathetic. Let’s take a look at the top splits that have been announced for 2022!

Alphabet (NASDAQ: GOOGL)

The first major company to announce a split this year was Alphabet. It is the parent company of Google, YouTube, and the Android smartphone system. By market cap, it is the fourth biggest company in the world and third largest in the US.

It is also one of six companies in the world with a current market cap of over $1 trillion. This year’s split will be the first real one in the company’s history.

With shares currently trading at around $2,500 per share, it is easy to see why the company wanted to make the stock more accessible. Alphabet’s split this year will be a 20 for 1 split and will take place in July. 

Amazon (NASDAQ: AMZN)

Are Stock Splits Good or Bad

Shortly after Alphabet announced its split, fellow tech giant Amazon joined in the fun.

The announcement was somewhat of a shock as Amazon has avoided splitting its expensive stock for years.

Many believed that former CEO Jeff Bezos did not want to split the stock, but it seems new CEO Andy Jassy has a different idea.

Amazon has split its stock three times, all of which came during the dotcom bubble years in 1998 and 1999.

This year’s stock split for Amazon will be a 20 for 1 split as well and will take place in June. Some believe both Amazon and Alphabet are splitting their stock to be included in the Dow Jones Industrial Average. 

Tesla (NASDAQ: TSLA)

Less than two years after the company’s first ever stock split, Tesla announced another one is coming this year. In August of 2020, Tesla split its red-hot stock 5 for 1.

This year’s split still needs to pass a vote later this year, but chances are this vote will pass. No other details have been released so nobody knows the ratio or date it will take place.

Most believe it will be in the area of a 4 for 1 or 5 for 1 stock split, given its current price of just above $1,000 per share. 

GameStop (NYSE: GME)

The lead meme stock also turned heads earlier this year when it announced its own stock split. There are few things that get retail traders more excited than a split, so GameStop is certainly playing to its crowd.

GameStop’s stock split is going to be slightly different. It’ll be in the form of a dividend. Most other details have yet to be released as a vote needs to pass at the annual shareholder meeting.

The proposed split would increase the number of shares from 300 million to 1 billion. With shares currently trading at just over $140, the split likely won’t be a significant ratio. 

Shopify (NYSE: SHOP)

The most recent company to announce a split is Shopify. The Canadian eCommerce giant was one of the hottest stocks over the past few years. So far in 2022, shares of Shopify are down more than 64% as the tech correction has hit the company hard.

Shopify announced its split would be a 10 for 1 split, and take place at the end of June. This will be the first official stock split in Shopify’s history. 

Should I Buy Before or After the Stock Splits

It’s a great question and one that I see frequently being asked. Understandably the natural inclination is to buy the stock ahead of its split. But with so many people thinking the same way, you’ll likely be buying the stock at its high.

A stock split isn’t a fundamental business event, so it can artificially raise the price of the valuation. The translation of this is that there is a good chance the stock price will actually fall post-split. 

But for some reason, investors think that holding a stock through the split is better than buying the shares post-split. For example, if you buy one share of Alphabet now you’ll receive twenty in July.

But nobody wants to buy twenty shares in July, they want to see their single share split. There isn’t really a tried and true time to buy a stock that is going to split. Some will say buy it before to gain the value of the surge into the split.

While some will say buy the stock post-split when the price has levelled off. At the end of the day, this is something that is totally up to the individual investor. Like I said before, it really doesn’t matter when you buy the pizza, it just matters that you own it. 

Leave a Reply

Your email address will not be published.