Webcast #19: Why Stock Splits Can Raise a Share Price (8 minutes)

Stock splits are akin to exchanging a dime for two nickels. It doesn’t change the economic value of the company. If a stock trades at $50/share and a shareholder owns 100 shares, the value of the investment equals $5,000. If a 2-for-1 stock split is announced, the same shareholder will be given an additional 100 shares and the stock price will drop from $50/share to $25/share. The new value for 200 shares trading at $25/share remains $5,000, unchanged from before.

However, despite no change in economic value, a stock split can expand the shareholder base to include more retail investors with smaller account sizes and result in a higher share price. For example, if a small retail investor had $10,000 to invest and wanted to take a 5% position in Alphabet (formerly Google), a $500 total investment would be required. However, because Alphabet accompanies a $2,500/share stock price, the minimum allocation would need to be 25% of this person’s investment account, five times larger than a 5% position.

Alphabet recently announced a 20-for-1 stock split to overcome this dilemma, which will make one share trade for $125 instead of $2,500. Now, if that same retail investor above wished to make Alphabet a 5% position in their portfolio, a purchase of 4 shares will achieve that objective. Without the split, this person would not have bought the stock.

Amazon, Shopify, and Tesla have also announced their intentions to split their respective stocks soon.

Research from the Bank of America suggests that companies that split their stock perform roughly 16% better than other publicly traded companies in the 12 months following a split.

Berkshire Hathaway principals Warren Buffett and Charlie Munger have been critics of stock splits for many years. The two want minimal shareholder turnover, an objective achieved by not increasing the volume of shares traded. One share in Berkshire Hathaway Class A now costs $516,000. However, in 2010, the company split its Class B shares 50-for-1. At $344/share today, investors can buy Class B stock in the company without needing to make a half a million dollars commitment. In other words, despite their many years opposition, both Buffett and Munger appear to have changed their tune on stock splits.

Notably absent from recent stock split announcements are the Canadian banks. Historically speaking, as a rule of thumb, once a Canadian bank stock approaches $100/share, the company takes action to split the stock. Royal Bank ($137/share), the Bank of Montreal ($143), and CIBC ($145) are overdue for a split while TD Bank ($94), National Bank ($94), and Scotia ($85) are ripe for an announcement.

While many investors are indifferent to the absolute dollar value of a stock, we agree with the principle to expand a shareholder base by splitting a company’s stock.