Episode #37: The WHY Behind Stock Splits
What are stock splits? Why would a company want to split their stock? Did you know you can now by fractional shares of a company? In this episode of Making Finance Fun, I talk about what a stock split is and why companies do them. I also touch on Apple and Tesla’s upcoming stock splits and what could happen in the aftermath. Lastly, I refute some common misconceptions about stock splits. If you’re wondering what all the fuss is about stock splits, this is a can’t-miss episode.
Outline of This Episode
- [4:48 ] What is a stock split?
- [7:26 ] WHY do companies split their stock?
- [10:48 ] Buying fractional shares of a stock
- [14:05 ] Apple’s upcoming stock split
- [17:02 ] The Tesla stock split
- [17:39 ] Misconceptions about stock splits
What IS a stock split?
According to Investopedia, a stock split is: “A decision by a company's board of directors to increase the number of shares that are outstanding by issuing more shares to current shareholders.” The share price is reduced in conjunction with the number of shares increasing.
For example, if you’ve got a company that’s trading at $200 a share and they do a 2-for-1 split, it will go down to $100 a share. A 3-to-1 split will go down to $66 a share. But it’s a net-zero event when it happens. Why? If you’ve got $10,000 worth of stock before a split, you still have $10,000 worth. It’s just more shares at a lower price.
WHY would companies split their stock?
Apple has been trading around $500 a share. Because it’s so high, it can be a deterrent to purchase the stock and it might scare some investors away. So there are two reasons I see why a stock might split.
- A company's Board of Directors wants to make the sure price more attractive to regular everyday investors.
- The second reason is that it increases the number of shares that are eligible to be traded, which increases liquidity. In the case of a 2-for-1 stock split—the number of shares outstanding doubles.
People like to buy stocks because they’re liquid and fairly easy to sell—unlike, say, a house. Even if you sell your house the same day you list it, you still have to wait for the deal to close. They’re an illiquid investment.
How could buying fractional shares of a stock change the split game? Keep listening to hear my take.
The history of Apple’s stock splits
Apple announced a 4-to-1 stock split that will take place—or took place, depending on when you’re reading this—on August 31st, 2020. According to 9to5 Mac, “Apple has split its shares four times in its history, with the value of those shares typically rising by an average of 10.4% in the year following the split, eToro said.”
Apple split in 2014 and 1 year later, the stock was up 36%. But when Apple split in 2000, its stock was down 61% the following year (which could have been impacted by the Dot-com Bubble). Of course, we don’t know what will happen this go-around.
In this study, eToro analyzed 60 years of data and found that—on average—companies that split their stock saw share prices surge by a ⅓ in the 12 months after the split. Averages can be deceiving, so I advise you to be careful.
What do I think about the Tesla stock split? They’ve NEVER split before, so no one knows what will happen. However, by the time this episode airs, it will be after the 5-to-1 split that happened on August 28th. So I guess we wait and see!
Common misconceptions about stock splits
What are the common misconceptions I hear about stock splits?
- Misconception #1: The stock is going to explode after the split. “MegaBrands” often see share growth within the year after a split. Apple averages over 10% in the year following a split. But there is no guarantee that stocks will go up after a split.
- Misconception #2: I should buy after the split. Whether you invest in the stock before or after the split, you’re still investing the same amount of money. Instead, you should focus on WHY you’re buying the stock in the first place.
- Misconception #3: They just want to buy their own stock back at a cheaper price. Maybe? But that isn’t usually why companies do stock splits.
A stock goes up when more people buy it then sell it on a given day. A stock price goes down because more people are selling than buying. If this keeps occurring, the performance could suffer. If it occurs because a stock price is too high, splitting the stock is an easy fix to protect their shareholders. To hear the full details about stock splits, be sure to listen to the whole episode!
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