Share splits have been on the agenda recently, with GameStop Corp (NYSE:GME) becoming the latest to announce it will be making the move, following Amazon.com Inc (NASDAQ:AMZN) and Tesla Inc (NASDAQ:TSLA).
The splits are a tool used by companies, often with larger share prices, to increase the number of shares in issue, to reduce the face value of each one to something more accessible for smaller investors.
It doesn't affect the total market cap of the company.
The best analogy is to compare it to cutting a cake.
FIrst, the cake is cut four ways, with four people taking a slice each. It is then cut eight ways, meaning all four people have two slices, but they still have the amount of cake.
Why do companies undertake share splits?
From an organisation’s point of view, the overriding argument is that a split will increase liquidity, as a smaller price can attract private investors into buying and trading the stock.
Shares can be traded more easily, in theory.
According to Russ Mould, an investment director at AJ Bell, “it helps investors with smaller portfolios to run a diversified portfolio.”
What happens to the share price?
As explained, the share price becomes smaller as one share is split into three, in the case of GameStop, and the actual value of the company is unchanged.
If GameStop’s share price remains at US$180 when the split takes place, that will make each stock worth US$60.
So, you may be confused about what happens when a company reveals a stock split, as the recent high profile ones triggered saw prices rise.
Do investors view this as good or bad news? and react accordingly in the market before the split occurs?
In GameStops case, shares are up 5% so far today to US$180.
However, that doesn’t really tell us much given that the stock is performing strongly anyway this year, up 25%.
On the day that Amazon announced its share split, 9 March, shares also climbed 5%.
Tesla said it was seeking its second stock split in two years earlier this week, and shares inched slightly higher, but higher nonetheless, climbing 3%.
So, it seems like the announcement of a share split is usually met as a positive thing by the markets on the small sample size considered.
Of course, the obvious reason for that would be greater liquidity, with the move viewed as opening the doors to a whole new level of investors eager to get their hands on high-performing stocks.
Mould argues, however, that more shares don’t make it a better investment, and the market should continue to value stocks on traditional measurements, such as performance.
“As Warren Buffett is always misquoted as saying, his favourite holding period is forever, so if the company is a good investment, why should you worry about being able to nip and out and trade its shares?”
“Nothing changes except the share price and the share count, ultimately, so it’s really a cosmetic exercise and one that in no way changes the fundamentals of the company, or the investment case for it,” said Mould.
“The core of the investment case in turn will always rest on the competitive position of the company, its financial strength, management acumen and then valuation. Not one of those changes in the case of a stock split.”
So, other than providing smaller private investors to get their hands on a whole share, stock splits have little impact on the company as Mould puts it, is “cosmetic exercise.”