Why You Are Wrong About Stock Splits
Aka why I am tired of explaining market caps
Pop Quiz hot shot…Amazon is having a 1-for-20 stock split and that means
A) Your Rich!!! You own 20x more Amazon
B) Amazon’s stock price can now increase from $120 to $2,400 a 20x return
C) You can buy more Amazon, Jeff Bezos better watch out
D) The price of Amazon dropped and its back to eating ramen for you
E) Absolutely Nothing - there is no impact from stock splits
For some reason, stock splits confuse a lot of people and they shouldn’t. [F’er looks up a news release on the Amazon stock split…pauses…yells at the universe….].
Correction, I do know why you are confused, a bunch of dopes write garbage news releases implying all sorts of benefits. Financial news sucks, bro.
Stock splits literally should be non-events. Even the SEC is crystal clear that stock splits have no fundamental change. But is there any benefit?
Stock Splits Do What???
“Amazon shares soar after announcing stock split”
“The last time the company split its shares was 1999 and the stock has returned over 4,500% since then”.
“The split makes the stock more affordable for retail investors”
“This split gives Amazon employees more flexibility in how they manage their equity in Amazon”
These are 4 direct quotes I pulled from a single emailed out news release from a highly-used stock website.
Listen, I get these writers need to get clicks. And these are clickbaity pull quotes. But a few of these border on malfeaseance how poor they are.
Let’s clear this up once and for all.
What Does A Stock Split Do?
Stock splits literally split each existing share into more shares. The price of a share adjusts accordingly and your total market value remains unchanged. Pro-tip, market value is what you care about. That is your actual wealth.
If you have 1 share of Amazon at a $2,500 price you have $2,500 market value. If the next day Amazon starts trading post 20:1 split, you will open your account and see 20 shares of Amazon at a $125. Your market value is still $2,500 (20 x $125 = $2,500).
This is literally the old Yogi Berra quip:
Yogi was at a pizza parlor and ordered a large pizza. The waitress asked if he wanted it cut in 4 or 8 slices. Yogi replied
“Better make it 4, I’d never be able to eat 8 slices”
The joke being that if you take a pizza and cut it into 4 or 8 pieces, you didn’t make more or less pizza. Same concept with a stock split. You took the company’s market capitalization and just split it into more pieces, but the ‘value’ doesn’t change. From this perspective, it is a non-event.
(Note - Market capitalization (market cap) is the number of outstanding shares x the price of a share. It is the total equity value of the company in the market. A company with $1,000 market cap can have
1 share outstanding for $1,000
10 shares outstanding for $100
1,000 shares outstanding for $1
Any combination of shares & price that adds up to $1,000
A company can split or reduce their shares anytime to make more or less pieces of the company. But it doesn’t change the total equity value of the company.)
So now that you know what stock splits do, what don’t they do.
Do Stock Splits Make Share Price Increase?
No.
As stated above, it is literally making more pieces of a pie. Cutting a pizza into more pieces doesn’t magically allow you to add those pieces together and get a bigger pizza. Fundamentally there is no reason for the share price to increase.
To be honest, stock splits should be an immaterial bad guy to the finances. It involves filing work, proxy vote, additional accounting work, and debate of executives. It isn’t a frictionless event, and that means there is a cost to it. For a company as big as Amazon, a 6-figure cost is a rounding error, but it is still a negative from a pure Income Statement view.
Do Stock Splits Lead to Long-Term Growth?
No.
Honestly, this section is only here because of that jaw-dropping line in the news alert. “The last time the company split its shares was 1999 and the stock has returned over 4,500% since then”.
That is such a ridiculous comparison. It is a prime example of correlation and causation. I didn’t paraphrase this quote. Someone got paid to put that in an update and thought it was ok. To imply that the stock split in 1999 was some triggering event for the last 20 years growth is dumb. Even worse, it implies there is a chance of similar growth going forward because of another stock split. This is ludicrous.
Back in 1999, Amazon did 2 stock splits. At the time its entire market cap was around $30 Billion or so. It was a big company even then, but doing a 45x to get to the behemoth $1.3 Trillion it is today was an absolutely crazy run. Since a stock split doesn’t change the market cap, to do another 45x from here would put Amazon over $45 Trillion market cap. The current market cap of the entire SP500 is roughly $40 Trillion. To put that in perspective, Amazon would be worth more than the 500 largest public companies if it did grew another 4,500%. Implying that because last time Amazon did a 45x going from $30B to $1.3 Trillion, it may happen after this stock split is atrocious.
[Note - lets ignore the 30% annual inflation elephant in the room for the moment. Honestly, if inflation keeps it up, Amazon may be $45 Trillion market cap solely because the value of the dollar is down 95%]
Stock splits don’t impact the underlying business or profitability, therefore, there is no reason it drives long-term growth in a companies market capitalizaion.
Do Stock Splits Make Shares More Affordable for Retail?
No. Mostly.
Most brokers allow trading fractional shares now. If you want to buy $150 of Amazon, you can do it today and own some fractional share amount. The only benefit of a stock split is lowering the per-unit price shown. So yes, small retail may be able to hold ‘1 full share’, but that share is less value. You are essentially no different if you own 1 share post split or 0.05 shares today. It isn’t ‘more affordable’.
Not to mention, most retail holdings of Amazon is likely in retirement accounts as part of ETFs rather than direct purchases of Amazon shares.
This really only impacts a very small segment of retail investors who:
Have accounts so small that taking a $2,500 position in one stock is too much
But still purchase individual names instead of ETFs
And want to own Amazon directly
And refuse to use one of the many brokers who allow fractional shares
I imagine that is a very small subset captured under the 4 points above. So I can’t say this is 100% a no, there may be a handful of retail that now can finally buy some Amazon. But it is essentially so small that stating this ‘makes it more affordable for retail’ is a huge stretch.
Do Stock Splits Allow You To Buy More ‘Ownership of the Company’?
You had 1 share, now you have 20 shares. So you own more of the company right? Soon you are going to be challenging Bezos for supremecy with your large share count.
No. Sorry. Bezos is safe. You may own more shares post split, but each share gives you less ownership of the company. It is a wash. (Also, Jeffy’s count just went up 20x as well.)
If a company has 10 shares total outstanding in the entire market and you own 1 share, you own 10% of the company. If the company does a 2-for-1 split, you have 2 shares now. But the company’s total shares outstanding is now 20 shares. Therefore, you have 2 shares out of 20 total = the same 10% of the company you started.
You do not own more of the company after a split, despite your nominal share count being higher.
Do Stock Splits Give Employees More Flexibility?
…..maybe….?
This seems like one of those corporate stretches where they grasp at straws to spin everything into a win for their employees.
Maybe post split you can sell $125 worth of Amazon at a time. (This assumes employee stock purchases/rewards are held at a broker that doesn’t allow fractional sales).
If I had to make a bet, I’d bet the answer is more that this split benefits Amazon. If Amazon didn’t gift out fractional shares, the lowest reward would be 1 full share at $2,500. Therefore, after the split they could gift 10 WHOLE SHARES!!!!! (at $1,250 value instead).
I’d wager the stock split is more about giving Amazon the ability to continue to screw over employees. The company known for basically making its workers pee in a bottle with one hand while continuing to pack boxes with the other probably isn’t making decisions to give employees some benefit. Just saying.
Amazon has been hiring thousands of employees and hiring at high per hour rates. Using equity instead of salary for compensation has a benefit on the financial results as well.
(Note-No I did not look up Amazon’s employee stock purchase plan, employee stock reward/incentives, or anything. Honestly, I don’t care. But feel free to comment if you have the information around it. I stand by the general theme above. It is a stretch to say the stock split adds all sorts of flexibility for employees but definitely adds a benefit to Amazon.)
Are There Any Actual Benefits to a Stock Split?
“Allright, I know the answer to the quiz. The answer is E - there is absolutely no benefit of stock splits”, you yell at evil Dennis Hopper.
Kaboom.
The bus explodes. You killed young Sandra Bullock and everyone aboard, Anon. The world will never know the joy of Miss Congeniality 1 & 2.
Even though there is no fundamental change to the value of your holdings from a company doing a stock split, there are some potential benefits.
Stock splits & reverse stock splits can help with inclusion in indexes.
A reverse stock split is reducing the share count by combining X shares into 1
Psychological Impact due to unit bias and round number bias
Change or control the narrative
I also mentioned that if Amazon is able to use more equity in its compensation now that the share price is lower, there will be a financial benefit. But let’s briefly hit these points above.
Stock Splits Can Impact Inclusion in a Stock Index
Share price, number of holders, and outstanding shares are all factors considered for inclusion in stock indices. This stock split may help Amazon make it into the Dow Jones index. Dow Jones can’t allow high share price stocks into the index since it is a price-weighted index.
Stock indices (SP500, Dow Jones, etc.) have rules for inclusion. Dow Jones is a price-weighted index of 30 US companies. Basically, the index value is the sum of 1 share of each ofthe 30 companies divided by 30. This means that if you had Amazon at $2,500 share price and Coca-cola at $50 a share, Amazon’s price move would have an outsized impact on the DJIA.
KO’s market cap is ~$250 Billion vs $1.2 Trillion for Amazon. So KO is about 1/5 the size of Amazon, but Amazon would have a 50x higher impact on the Dow Jones since its price is 50x higher.
Inclusion in an index has an impact to a stock that is measurable. First, all the index trackers or ETFs will need to buy a bunch of shares of the company. Then every investor who buys an ETF in their retirement account is buying a partial position in the company.
“Price Goes Up After A Stock Split”
Wait, didn’t you just spend 100s of words saying there is no fundamental impact of a stock split and used pizza analogies and everything?
Yes, I did. But guess what, there is an entire behavioral and psychological impact to stock prices that ignore fundamentals. Yes, stock splits have no fundamental impact (if anything a small negative valuation impact due to higher expenses to do the split).
However, historically there is a little bump on the announcement of a stock split solely based on traders playing the meta game. The “meta game” here is a nice way of saying “retail investors are dumb and will buy because shares looks cheaper. So ‘smart’ money buys it first to dump on retail after the bump”.
Why does retail buy the stocks after a split? Unit Bias and Round Number Bias
Small Unit Bias and Round Number Bias
Literally the only reason the price goes up in a stock split is smart money relying on your cognitive bias for holding small-units. (he he he). People are going to see Amazon at $125 a share and think how it was over $2,000 a share once, and say “there is so much upside and Amazon was $2,000 before so they can get there again”. This is a gross misunderstanding how any of this works.
A $1,000 stock price seems big. People think there is less room to go up. Seeing a $1 a share stock price seems small and like there is a lot of room for growth. If you are looking at 2 stocks, most people will lean towards buying the $1 stock because it ‘appears’ to have more upside. “To go from $1 to $2 is only a $1 increase, but going from $1,000 to $2,000 is a $1,000 move”. This ignores that a double in market cap is a double in market cap. It is just as easy for a share price to double from $1 to $2 as it is to double from $1,000 to $2,000, all else equal.
The best example is Berkshire Hathaway’s A-shares. If you brought a share for ~$1,500 back in 1984 and held to today, your return was ~15% a year. The price is up like 300x over the nearly 40 years. The price of 1 share is $489,800.
The second cognitive bias is your preference for round numbers. You could likely have purchaed 1 shares of Amazon today at a share price of ~$2500 OR post split buy 20 share at $125. No difference, other than you’d rather see 20 share instead of 1 shares in your brokerage. You just want a nice round number.
(Oh…you don’t think so anon? Go to your brokerage and look at recent transactions. How many of them end in 5 or 0? 100 shares, 50 shares, 25 shares, etc. Probably a lot of them right? You like round numbers too. People don’t trade 32 share lots).
Changing the Narrative Around the Stock
A massive amount of time is spent crafting the storyline for earnings and investor days. Stock splits are a corporate event that allows a company to have a talking point and a story to focus analysts on.
This doesn’t change the fundamentals of a company, but markets aren’t efficient and narratives absolutely drive stock performance, atleast near term.
Read the press releases around this stock split. It is all about how this move by Amazon helps small retail investors make money by investing in Amazon’s success. (“4,500% growth since our last stock split, YOU too could see that performance in your portfolio now. All because Jeff Bezos is such a nice guy and wants to help you…). Or how it helps employees. Amazon is trying to build a story as helping the little guy.
Also did you know Jeff Bezos isn’t even the CEO of Amazon? Andy Jassy is. Jassy became CEO of Amazon in July 2021. Guess if the stock price was higher or lower in July? Yup, higher, by a lot. It was ~$3,600 a share last Juy and under $3,000 a share today. About a 20% drop. Doing a stock split has sucked up all the attention this news cycle and took it off the dismal stock performance under the new CEO.
Other Benefits of Stock Splits
There are additional benefits of stock splits that don’t really apply to Amazon. Other potential benefits of stock splits include:
Increasing liquidity of a company that had a low free float of share
Increasing the number of owners
Increase volume of shares traded
Wrap-Up: What is the Impact of Stock Splits?
There you have it. That ran a lot longer than I was planning. But I have seen poor takes on the stock split on both sides.
It is fun to fire off a hot-take tweet at all the dopes who think the stock split of Amazon gave them more ownership or makes for higher future returns. “Idiots, the share price shouldn’t change, its carving up the pie differently”.
However, there is a real effect on share price exactly because of the change in narrative and market psychology. “Your bottoms-up valuation analysis can’t explain the price bump nerd”.
Now you know enough that you could be the Keanu our hypothetical example of a bomb on a bus that blows up if you don’t understand stock splits. Congratulations, you get to live…atleast long enough till you wind up on a cruise ship with a bomb….
(Also, note that Amazon also announced a $10 billion share buyback at the same time which could be impacting the near-term share price.)