On July 30, Apple announced a move it hadn’t made since 2014: it announced a 4 for 1 stock split. Given the dramatically different investing landscape in 2020, the news should have been met with a collective yawn, if not scorn from investors for going to the expense and trouble. Instead, the stock price soared by over 10% the next day, and 18% over 5 days. Certainly some of the gain was in response to strong earnings, but clearly much of it owed to the announcement of the split. In a rational world, this shouldn’t have happened. But “rational” is not an adjective comfortably applied to the current market environment.
At the most fundamental level, nothing really changes after a split. The transaction involves issuing additional shares, and reducing the price per share proportionately. Suppose you owned 100 shares of PetRock.com presently valued at $20 per share, a position worth $2,000. If the company announced a 2 for 1 split, you would receive an additional 1 share for each share you owned, for a new total of 200. However, the price of each share is reduced proportionately (by one half in this case), to $10 per share. Your position is essentially identical: 200 shares at $10 for a total of $2,000.
Once upon a time, stock splits made sense. First, trade commissions were a significant factor in the total cost of an investment. Until 1975, trade commissions were fixed by regulation, guaranteeing a virtual oligopoly among the big brokerage firms who charged rates running into the hundreds of dollars for what was known as “round lot” or 100 shares. Given the high trading costs and 100-share minimums, many stocks were out of reach of smaller individual investors. The answer was to split the shares, dropping the price of a round lot to within reach of more potential buyers.
Today, the situation has shifted drastically. The deregulation of brokerage commissions and proliferation of “discount brokers” started a range war that ultimately drove commission rates to zero. Furthermore, many brokers are now offering clients the ability to purchase fractional shares. Now even the smallest investor can invest $320 to purchase 1/10 of a share of Amazon stock. With no commission.
Stock splits have largely disappeared in view of these developments, and rightly so. In 2019, only 3 companies split their shares, compared with 102 splits in 1997. So why the Apple move?
Marketing. In spite of the plethora of information and the structural shifts that have rendered stock splits meaningless, many investors apparently still believe they add value. There is something psychologically ineluctable about getting more of something for less money. So when Apple announced that every share will turn into 4 shares, many retail investors reacted positively in spite of the fact that nothing had changed. By creating the illusion that Apple was now a bargain, the company enhanced its brand awareness and created a buzz that boosted share prices higher.
Be assured that the lesson was not lost on other relatively high-priced companies. Tesla declared a 5 for 1 share split affecting shareholders of record as of August 21. And there are currently a dozen other stocks priced above $500 per share on the S&P 500 that are attracting speculation.
Many observers have expressed concern about market valuation, particularly in light of the large inflows from inexperienced retail investors, some of whom are seeking an alternative thrill given the Covid-related hiatus of sports betting. The irrational exuberance over Apple’s split announcement does little to allay those concerns.
Christopher A. Hopkins, CFA