It seems like every hot stock on the market is doing a split these days.
In the last two years, well-known stocks including Apple, Amazon, Alphabet, Tesla, and Shopify have all announced stock splits or have carried them out. Tesla even filed to do a 3-for-1 stock split just two years after splitting its stock 5-for-1.
The stock-split trend has sparked a wave of chatter unlike ever before. Google searches for “stock splits” have spiked to record highs this month, and sleuths on online forums like Reddit’s Wall Street Bets are busy figuring out the best way to play stock splits.
Just a different way of cutting up the company pie
The thing investors need to remember about stock splits is that they’re fundamentally meaningless to the value of the company. While the share price changes, the value each share represents doesn’t. It’s just splitting a pie into more pieces. Whether the pie is divided into eight pieces or 16 pieces, it’s still the same size pie.
The “value” then in stock splits is entirely about perception. Unsophisticated investors often believe that the price of a share itself indicates how cheap or expensive it is. They’d argue that a $30 stock is much cheaper than a $1,000 one, but comparing stock prices this way is meaningless. You have to consider how much profit a company makes per share and other such financial metrics like return on investment, free cash flow, or revenue. The share price of an individual stock is only meaningful in relation to those key metrics for that company. A stock split makes individual shares cheaper, but the nominal value of that share is irrelevant without broader context.
The stock-split mania of the past couple of years is reminiscent of the dot-com bubble when companies repeatedly split their stock on their way up during the boom before crashing hard. There are a few lessons we can take away from the current wave of stock splits.
Retail investors have flooded the market
The pandemic was a perfect storm to drive interest in the stock market. The combination of rising stock prices, boredom from stay-at-home orders, and even a lack of sports to bet on sparked a wave of new investors in the stock market taking advantage of trading apps like Robinhood Markets, which saw a boom in new users.
On Robinhood, funded accounts exploded from 5.1 million at the end of 2019 to 22.7 million at the end of 2021, and according to The New York Times, an estimated 20 million amateur investors started trading during the pandemic. While some have been flushed out by the bear market with trading activity on platforms like Robinhood and Coinbase Global declining, many remain, and many of those investors seem to be focused on gimmicks like stock splits.
In other words, there are still a lot of unsophisticated investors in the market, which is one sign that stocks could have a lot further to fall.
Companies are taking advantage
Not every stock split is a gimmick of course, and there are valid to reasons for splits. Companies like to keep shares affordable for individual investors, and splits act as something of a milestone for stocks that have put up long-term growth. For a company like Amazon, the recent stock split could also help it gain membership in the Dow Jones Industrial Average.
But at this point, it seems like some companies are taking advantage of the increased investor interest in stock splits. Shopify and Tesla, for example, announced their splits after significant drawdowns in the stock. That’s unusual, as stocks typically split after a long run-up in value, enacting a stock split on strength rather than weakness as these two are doing now.
What investors should focus on
Rather than focusing on the near-term impact of stock splits, investors are better off spending their time researching the actual fundamentals of these stocks that affect their valuations. The metrics that matter more are things like free cash flow, profit margins, and revenue growth, as well as share buybacks or dividends.
For long-term investors, stock splits aren’t a reason to invest in a stock. In fact, they shouldn’t be material to your investment thesis at all.