The Beauty of Doing Nothing
What does a stock split do? It doesn’t do anything… That’s the beauty of it.
Tesla ($TSLA) announced a 5 for 1 split of its stock to be completed on Aug. 31. The move by Tesla follows Apple’s ($AAPL) 4 for 1 stock split announced on Jul. 30.
Financial hand waving
On Aug. 31, every Tesla stock that you own will turn into 5. What’s the catch? Each stock will be worth a fifth of what it was worth before. Stock splits were massively popular back in the 90s with an average of 64 companies splitting their stock each year. That number dropped to 9 over the past decade.
Companies often split their stock to make it more affordable for everyday investors. The invention of fractional shares, the ability to purchase a fraction of a stock, made stock splits redundant. Stock splits cost companies ~$800,000 which makes them even less attractive.
Don’t celebrate… or do?
Stock splits are mere cosmetics that should not impact stock prices. Turning your five-dollar bill into five one-dollar bills should not make you any wealthier… Unless your bill is manufactured by Elon Musk. Tesla’s stock price increased 17% in the 2 days following the announcement.
The lack of science behind stock splits
A research study by David Ikenberry, a Professor of Finance at the University of Colorado, revealed stocks that split their shares outperform the average market return by 7.9% in the year after a stock split.
There’s no definitive explanation on why prices go up after stock splits but here are two theories:
- Theory 1: Splits are a signal that management expects their stock prices to continue rising.
- Theory 2: Investors have a bias in buying stocks with lower prices thinking they have more room to increase.
Take no action: Investors should not solely use stock splits as a reason to buy. They do not fundamentally change anything in a company.