Every now and then, in the news you hear a new term. For me that was the term ‘stock split’. Apple and Tesla both went through a so-called stock split last month, but what does this mean for the shareholders? And what about the companies themselves? In this short article I will try to answer most of these questions and provide some other relevant information about stock splits in general.
What is an example of a stock split and how does it work?
So first I will try to make the concept of a stock split more clear. A stock split is basically an instrument a company can use to increase the amount of stock available in the market. The company does this by literally multiplying the amount of stocks everyone owns by a certain amount. Take for example the four-to-one Apple stock split that happened at the end of August this year. Let’s say I owned 10 shares of Apple before the stock split, priced at say 500$ per share. Then after the stock split I would now own 40 shares of Apple priced at 125$ per share. Note that the total amount of money invested does not change. The amount of shares just multiplies by four and the value of a single is divided by four.
Why do certain companies like Apple and Tesla consider a stock split while other companies don’t?
So, why would a company consider going for a stock split? This could be for multiple reasons. The first one that comes to mind is to make the stock more liquid and increase the market volume. This makes it easier to trade the stock and could even decrease the width of the bid-ask spread. A second reason could be to create a quick increase in market cap, which happened to both Tesla (12.6%) and Apple (3.4%), by announcing their stock split. One thing to notice however is that a stock split is also only something that occurs with companies with a strong brand name. This is because companies without a strong brand name generally don’t gain anything from a stock split. Where companies with a brand attract many retail investors, companies with a brand do not. When retail investors are in the picture, speculative behaviour will affect the share price and self fulfilling prophecies will on occasion happen. But when the only big investments come from funds this will not play a role, because these funds generally do their research and keep the share price at a level that is actually worth. Hence why Apple and Tesla went for a stock split but other less known companies did not.
What are the sudden changes in the market that one has to look out for surrounding a stock split?
Since stock splits are mostly cosmetic, they should in reality not affect the market cap of the companies. But in the case of Apple and Tesla they did and not by a small margin, so why could this be? There has always been a hype around certain tech companies and Apple and Tesla are prime examples of this phenomenon. And this is where the brand name mentioned earlier also plays a big role. The hype around the Tesla and Apple stocks becoming more affordable could have well been the cause of this sudden surge in share price. A lot of retail consumers have some kind of attachment to these companies making them more prone to buy stocks if the right opportunity comes by. Trading in fractional shares, which is a way to counter the bias of high share prices, is still not the standard for most brokerages. And that is why a stock split does in fact, as I stated earlier, make the stocks more accessible for the average Joe and make retail consumers buy these stocks.
And finally: what kind of traders are most affected by a stock split?
There are multiple different types of traders. The announcement of Apple’s and Tesla’s respective stock splits made the market highly volatile. This high volatility in the market is essentially only important for short term investors and day-traders. This would have, for example, been a great opportunity for option traders, since a rise in price makes the call option worth more but a rise in volatility also causes the value of call options to rise. For the long term investors this short term high volatility has less of an impact since the long term traders intend to hold the stock much longer and follow a much more steady upwards trend in general. After the stock split occurred the so called Tesla bubble burst and we witnessed a drop of over 30% followed by a small recovery. This big drop after the stock split most likely occurred due to retail investors realizing that a stock split is mostly cosmetic and no big reason to increase demand by a lot. This also mainly impacted the short term traders, who, if predicted correctly could have made a big profit by short selling Tesla stock. Tesla will most likely bounce back, so luckily this big drop probably did not cause any real harm to Tesla itself. So in conclusion, investors should be extra careful around stock splits, but could also make a big gain from them.
To summarise, the stock split that Apple and Tesla went through created mostly gains for all parties involved. Both companies were able to make a big gain in market cap right after the announcements of their respective stock splits. Moreover, the short term investors were able to make a quick gain due to the price of the stocks going up. Traders do however, have to be careful around a stock split, because a big drop in price like in the case of Tesla could always occur. In the end, just keep in mind that a stock split is not anything very fancy and is mainly just cosmetic.