Reed C. Fraasa, CFP®, AIF®, RLP®
In the last two weeks, big news items were the announcements from Apple and Tesla that they will be splitting their stock on August 31st. Apple will split its stock 4 to 1, meaning you will receive four shares for every share you own as of August 24th.
The split will be Apple's fifth stock split in forty years. Tesla will split their stock 5 to 1 by issuing an additional four shares in a dividend for every share you own as of August 21st.
The shareholder has the same equity or value the day of the stock split. Although a shareholder's position in Apple will be four times larger and the position in Tesla will be five times larger, the share price will immediately be one fourth or one fifth.
Why Do Stocks Split?
A company will typically have a stock split to lower the stock price on the market, thinking it will make the company more attractive to smaller investors. However, nowadays, you can buy fractional shares of companies for free, so this thinking doesn't necessarily make sense any longer. You can purchase fractional shares of Apple, so what does the share price matter from one day to the next?
Is a Stock Split an Opportunity for Investors?
With all the attention the financial news media devoted to these announcements, you would think that a stock split is a big opportunity. However, we need to be careful not to conflate a stock split with fundamental valuation analysis.
Investors form their evaluation or bias of a stock based on information about the company's financials and market, and they either believe the stock is fairly valued, undervalued, or overvalued. Based on the same information, one person may view it positively and buy, and another person may see it negatively and sell.
If there is no fundamental change in a company's equity value following a stock split, why would investors believe there is an opportunity to buy a company that they otherwise would not have considered buying?
The answer is typically due to FOMO, the fear of missing out. There is a perception that stock splits lead to an investment opportunity, but that is not the case. Following a stock split, the market once again focuses on the fundamentals of the company.
What Happens to Share Value After a Stock Split?
According to research by Bespoke Investment Group, in the past five years, twenty-five companies in the S&P 500 have announced a stock split. On average, from the time of the split announcement through the effective date, the median gain was 2.3% with positive returns 78% of the time and outperformance 68% of the time.
Once the split became effective, though, future returns were nothing to write home about. While median returns over the following three, six, and twelve months were positive, more often than not, they underperformed the S&P 500.
Bespoke Investment Group
Apple's outperformance over the past forty years is due to its fundamentals, not its stock splits. In the data above, the opportunity to profit from a stock split is realized between the announcement date and the effective date of the split, not after the split date.
The recent announcements of Apple and Tesla reveal the same pattern. The table below shows the recent volume of trading and change in Apple and Tesla's rounded share price leading up to and following the stock split announcements.
In the nine days since the Apple announcement, the volume of trading in Apple is 71% greater than in the nine days before the announcement. The stock price was down 2% in the nine days before the announcement, and the price has been up 20% post announcement. Tesla is even more extreme, with the volume of trading increasing 125% in the three days since the announcement compared to the previous nine days. In the nine days before the announcement, Tesla stock price was down 8%, and the price is up 20% since the announcement. Neither of these company's fundamentals has significantly changed to warrant a 20% return in such a short period.
Does the recent activity indicate that investors were buying Apple or Tesla now because of a belief that stock splits lead to growth opportunities or an emotional feeling of missing out?
The evidence doesn't support the former. If an investor believes in either of these two companies' fundamentals, then why didn't they load up on the stock back in late March or early April when their stock prices were 30% to 45% cheaper?
Perhaps at that time, investors were likely compelled by another emotion – the fear of loss.
Consistently following a long-term, diversified investment plan that prudently considers your return expectations and tolerance for risk to achieve your life goals will help you avoid the emotional seesaw of fear of loss and fear of missing out.
Author’s Bio
Reed C. Fraasa is a CERTIFIED FINANCIAL PLANNER™ and founder of HIGHLAND Financial Advisors, a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, and investment management. Reed has 30 years of experience as a fiduciary advisor and is the author of The Person is the Plan®, a unique financial planning process. Reed was a frequent guest contributor on PBS Nightly Business Report and has been featured in the New York Times, Wall Street Journal, and Star Ledger newspapers.