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The inside scoop of stock splits – what investors need to know

Sophie Lund-Yates, Equity Analyst, takes a look at stock splits after Apple and Tesla’s high profile moves.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

The financial newsreel has seen a lot of focus on Tesla and Apple’s stock splits in the last couple of weeks. Talk ranged from retail investors “pouring into” the stocks following the move, to the additional boost to Elon Musk’s already substantial wealth.

But for the everyday investor it’s not immediately clear what a stock split is, why they’re done or whether they actually matter. We’d like to fix that.

This article isn’t personal advice. If you’re not sure whether an investment is right for you, you should ask for advice. All investments fall as well as rise in value, so you could get back less than you invest.

While it might not seem that obvious at first, it’s less complicated than you think and the name’s actually on the tin. A stock split is when a company chooses to split existing high value shares into a larger number of lower value new ones. The important thing to note here is that your share of the overall company remains the same, it’s just divided into more units.

Whether or not to split shares is up to the company – Apple’s actually split its stock five times since it listed. The latest one on 28 August 2020 was done on a 4-for-1 basis, meaning each existing share was swapped for four new ones.

Why do companies do it?

A common misconception with stock splits is they’re done to raise money. Usually when a company creates new shares, it’s done for this very reason.

But stock splits are actually done to try and lower the price of shares. They don’t increase the share capital (number of shares multiplied by the share price) of a company, because the value of each share is split too.

Let’s say a company has a market capitalisation of £200,000, which represents 200,000 shares of £1 each. Following a 2-for-1 stock split, there would be 400,000 shares worth 50p each. The market capitalisation is still £200,000. But the price of each individual share has halved.

But if it’s a purely skin deep change why do companies bother?

Dividing the shares into smaller units can increase demand for the shares. This makes sense when you think about it – if the price of an individual share is say £500, then an investor with £750 to spend will only be able to afford one share. They might want more than that, so let’s say the company does a 2-for-1 split, making the shares £250, this small investor can afford to buy three shares.

Lower share prices are also useful when it comes to rewarding staff with share options. A company might want to give a junior member of staff a bonus in shares worth a few thousand dollars, but if the share price is too high it can’t do that very easily.

In extreme cases a high share price can also make mergers & acquisitions more difficult. At the time of writing, A class shares in US insurance giant and investment conglomerate Berkshire Hathaway are priced at $332,839. If the group wanted to buy out a company for $1,200,000 it would have to use a mixture of cash and shares to do so – even if it would rather pay entirely in shares – because its shares can’t be broken down small enough ($332,839 multiplied by three = $998,517, multiplied by four = $1,331,356).

How do they affect existing investors?

The overall value of your shares will be unchanged, apart from the usual market movements which can see share prices fall as well as rise. The only obvious difference will be that the number of shares you own has gone up. It’s as if someone gave you a slice of a cake, insisted on cutting your slice in two, but let you keep both halves. The whole still has the same amount of calories – it’s still the same amount of cake.

A little extra demand for the shares might make a slight difference to the share price, and the split has probably made life a little easier for management, but really nothing has changed. You own the same amount of the same company. You should treat your investment as you did before.

The key things to remember are:

  1. Stock splits create new shares by splitting old shares into smaller new shares, for example on a 2-for-1 basis
  2. They reduce the share price and increase the number of shares, but:
  3. Stock splits don’t change the intrinsic value of a company or your shareholding

So what’s going on with Apple and Tesla?

Both Apple and Tesla’s share prices reacted positively to their recent stock splits. The share price rises in the weeks after announcing the splits, and the days after they took effect, culminated in both companies reaching record share prices.

Remember past performance isn’t a guide to the future.

It’s important to note that these price movements aren’t being driven by the stock splits themselves. The announcement that shares were going to be divided up created media attention, which can tend to drum up extra demand. Tech stocks are also enjoying a run of increased popularity at the moment, (at least in part) thanks to coronavirus and the increased demand for technology.

Investors need to remember that the sentiment surrounding a stock split might affect the share price, but the stock split on its own won’t affect the intrinsic value of your investment.

Read our latest research on Apple and Tesla.

Unless otherwise stated estimates are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Past performance is not a guide to the future. Investments and income they produce can rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.


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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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