A Few Words on Stock Splits

Mark Meredith, CFP®

Originally published 08/13/2020

“Please cut the pizza into 4 pieces because I’m not hungry enough to eat 8.”

-Yogi Berra

Before I say anything critical about Tesla’s stock split, I would like to take the opportunity to remind everyone the stock is up about 300% since I questioned their market valuation in this post in January. Actually, that may actually prove the entire point of the article (Stock Picking is Hard).

On Tuesday (August 11th), Tesla announced a 5 for 1 stock split, meaning if you owned 1 share of Tesla prior to the split you will own 5 after it, at a share price 80% lower. Fundamentally it is a wash. Owning 1 share of stock at $100 is no different than owning 5 shares at $20 each.

There is a psychological dynamic to a stock price. Retail investors typically would believe a company like Ford Motor company, which trades around $7 per share is cheaper than a company like Seaboard Corporation, which trades around $2,900 per share. Every company has a different number of outstanding shares though, and Ford has about 4 billion shares while Seaboard only has 1.15 million. That makes Ford’s market valuation close to $28 billion, while Seaboard is only $3 – $4 billion.

Price alone tells you nothing about the value of a company. Berkshire Hathaway stock (A shares) is over $300,000 per share, but the company is worth less than Apple, Google, Microsoft, and Amazon with far lower share prices.

Someone might argue that in order for Ford to gain 10% it only needs to appreciate 70 cents per share, while Seaboard would need to gain close to $300 per share. There is no validity to this argument and if indeed a lower share price would lead to higher investment returns, every company should split their stock appropriately to under $10 per share to reap the benefits.

It Makes Shares More Affordable….

First of all, it’s not more affordable now than before the split announcement if the market cap valuation just rallied 20%. It’s actually more expensive.

Second of all, the narrative that Tesla is doing a good thing by making their shares more affordable to retail investors is questionable. The theory is that if someone could not afford a few shares of Tesla at a $1,500 per share price point, bringing in down to $300 will open the door for opportunity.

If you cannot afford to pay $1,500 for a share of stock, you probably should not be picking and choosing stocks anyhow. You’re most likely in the early accumulation phase of your investing life and cannot afford to properly diversify a portfolio across individual stocks, and may want to consider a more broadly diversified index fund instead (which isn’t just a prudent suggestion for early investors but most investors).

So Why Are Splits Driving Up Stock Prices?

Tesla is not the only recent split, their news came shortly after Apple announced a split at the end of July. Apple is up 20% since their split announcement, which is a cool several hundred billion in market cap valuation.

If stock splits add zero fundamental value, why are the prices going up? No one knows for sure but I have a few guesses.

  1. People naively think that a lower share price does add fundamental value (dangerous).
  2. People are buying because they think more people will buy and drive the price up after the split, and they’ll be able to dump their shares on someone else if things go sour (a little more dangerous).
  3. People are buying because it keeps going up (CODE RED).

Oscar Wilde coined the quote “People know the price of everything but the value of nothing“, which seems very fitting when it comes to individual stock analysis.

This article is for informational purposes only and is not a recommendation of Meredith Wealth Planning or Mark Meredith, CFP®. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be assumed that future performance of any specific security, investment product or investment strategy referenced in the Article, either directly or indirectly, will be profitable or equal to the corresponding indicated performance level(s). No portion of the Article shall be construed as a solicitation to buy or sell any specific security or investment product or to engage in any particular investment strategy. Any reference to a market index is included for illustrative purposes only, as it is not possible to directly invest in an index. Indices are unmanaged, hypothetical vehicles that serve as market indicators and do not account for the deduction of management fees or transaction costs generally associated with investable products, which otherwise have the effect of reducing the performance of an actual investment portfolio.

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