In recent weeks, Tesla completed a 3-for-1 stock split, following on from Amazon earlier in the summer, which split their shares 20-for-1. So, what is a stock split, and why do companies bother? We speak to AJ Bell’s investment director, Russ Mould, to find out more.
What is a stock split?
A stock split happens when a company decides to take the decision to issue significantly more shares to shareholders to reduce the price of individual shares. The board will offer these to current shareholders in a uniform manner on a single date, and as such do so without diluting their stakes or changing the overall value of the company.
For example, if a company Bananarama issues a 2-for-1 split, and the price of each share is £10, then following the split each shareholder will have two shares valued at £5 for every one share they owned before. If the total value of company’s was £100m before the split, the total value following the split will still be £100m – there will just be twice as many shares in circulation.
Russ Mould explains it through the lens of Tesla:
“In Tesla’s case, the 3-for-1 split means investors will own three Tesla shares for every one that they own now. But the share price will correct and drop accordingly, so the company’s total market capitalisation (value) stays the same and the monetary value of the shareholder’s total investment in Tesla also stays the same. All other things being equal, so does the investor’s percentage stake in the company.”
Why do companies split their shares?
Boards may take the decision to split their shares if they think the price is becoming prohibitively high and making the trading of their shares less appealing to private investors.
Mould explains:
“Companies largely think a share split helps liquidity in their shares – the ease to which their shares are traded – with the view that a big share price can be a deterrent to private investors in particular. Amazon carried out a 20-for-1 split for exactly this reason in the summer. The argument is that it helps investors with smaller portfolios, who find it harder than big pension funds or the big institutions who run huge pools of money, to run a diversified portfolio if just one share costs a lot of money.”
Do stock splits change the investment case of a company?
In no way does a stock split change whether a company becomes more investible or not, and even for ease of trading their shares, the jury is still out as to whether it helps much.
Mould adds:
“A split is really just a cosmetic exercise and one that in no way changes the fundamentals of the company, or the investment case for it. 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. The share price adjusts down and nothing much else, barring the share count, changes. As a result of this, in theory, the shares are more liquid because there are more of them and are thus easier to trade.
“But again, that does not make the firm a better investment. 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 in and out to trade its shares?
“And don’t forget that in 2008 you couldn’t trade FTSE 100 stocks that easily, no matter how many shares they had in issue, because everyone thought the world was ending and there were no buyers.
“Liquidity is not how many shares you have in issue. For an investor, liquidity is being able to buy or sell when you want, in the company you want, at the time you want and in the size you want. And the share count won’t make any difference to that the next time there is a market panic on, either.”
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