If you read financial news, you most definitely seen a lot of headlines in 2022 about huge companies undertaking stock splits: Amazon did it, so did Tesla, and Google. Accompanying these announcements are a flood of stories with a multitude of chuckle-ensuing titles such as “5 REASONS YOU SHOULD BUY TESLA BEFORE THE SPLIT” OR “HERE ARE 2 STOCKS BEGGING TO BE BOUGHT AFTER THEY SPLIT”. Why are these stories being written? A very simple answer: because you click them. I can hear you asking though: “But should I buy before the stock split? What if I miss out on a big gain that the article written by a bot talked about?”
What if I told you a stock split actually has no impact either positively or negatively on a companies inherent value either in stock price or total market cap? “But what about the stories?? They say I can make a lot of money because of the stock split?” Again, a stock split is purely cosmetic and no investment decisions should be made based solely on the split itself. So why is a stock split done? I will answer that in addition to what a stock split actually is and finally give you “3 STOCKS THAT ARE GUARANTEED TO DOUBLE AFTER THE SPLIT” (Just kidding)
Why is a stock split done? A company such as Google, Amazon, or Tesla performs a stock split because the price of their stock is too high in their view. Note - this is not that the company’s value is too high, rather the actual price of the company’s stock itself. Why don’t they want the price to become too high? Psychology. Really. There is study after study proving that a stock priced at $100 is much more attractive to a potential investor that the same stock priced at $1000, even with the company’s inherent value remaining constant. Take this test on yourself to see if it is true: imaging you have an extra $100 you found lying around and decide that you want to invest that $100 in Amazon stock. Amazon is worth right around $1.3 trillion, and their stock is selling at $1000. Now lets imagine in an alternate universe, Amazon is still worth $1.3 trillion, but their stock is only selling for $100 because they have 10x the amount of shares. Which one looks more attractive? The rational side of your brain is telling you correctly that $100 invested in Amazon is a $100, no matter if it gives you 0.1 shares in the first scenario or 1 entire share in the second. However, the other side of your brain is telling you: “I CAN OWN 1 WHOLE SHARE OF AMAZON AND I CAN BRAG TO MY FRIENDS ABOUT IT!!!”. There is something inherent in us as humans that want to own a whole something - not 1/10, even though the value of the initial investment has not changed at all.
What a stock split actually is? So we know why a stock split is done: again, to make the price more attractive to investors. But how is it actually done? Lets take Tesla’s split and use it as an example. Tesla performed a 3-for-1 stock split earlier this years. This means for every 1 share of Tesla that you own, you receive 3 in return. At the time, Tesla’s total market cap (how much the entire company is worth) was about $900 billion and they had around 1 billion outstanding shares (I did round to some even numbers for simplification). So simple math would be $900 total market cap/1 billion shares = each share was selling for $900. The company viewed this price as too high and decided to perform a 3-for-1 stock split. They filed the necessary paperwork with the SEC and performed the split. After the split, Tesla’s total market cap was still $900 billion - again this did not change no matter what the financial news stories imply - and they now have 3 billion outstanding shares instead of 1 billion. So some more simple math gets us to: $900 billion market cap/ 3 billion outstanding shares = $300 stock price. So if you owned 1 share before the split, it was worth $900. After the split, that 1 share is now 3 shares, valued at $300 each, or $900 total. Thus, your pre- and post-stock split investment is worth exactly the same.
In conclusion, there are an infinite amount of news stories out there pulling on every emotion. One piece of advice: take caution. Many are filled with misinformation or outright lies. The stories on stock splits is just one example of that. Stock splits are undertaken by companies who view their stock price as too high and want to make the price more attractive to investors for the long-term. The company performing the split’s underlying performance metrics and total market cap do not change.
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Life is worth the living, just because He lives,
Trey