Stock splits have been in the news recently with two of the higher priced, larger market capitalization companies, Apple and Tesla, announcing splits. Both stock prices have soared since their announcements. Stock splits always make headlines and typically are portrayed as a positive by market pundits and journalists alike. Digging into the topic makes one wonder…is it really a big deal?
We have heard many analogies for stock splits over the years, such as the “one dollar or four quarters” discussion, but our personal favorite is the pizza analogy. Say we have a publicly traded company, Widgets, Inc., with a market capitalization of $50b. If there are 100m shares outstanding the price per share is $500. If earnings are $100m then Earnings Per Share (EPS) would equal $10. If Widgets, Inc. does a 4 for 1 stock split, the company still has a market capitalization of $50b, but it now it has shares outstanding of 400m, a price per share of $125, and earnings of $100m which means EPS of $2.5.
In other words, you took a pizza, and cut it into 4 slices. The overall pizza isn’t larger or smaller, there aren’t more toppings or less toppings there are just more and smaller pieces. The company is the same, the earnings are the same, the only thing that changes is the number of shares, and the price per share.
If you are a large institution or a high net worth individual, a stock price of $500 or $125 doesn’t really matter. The ability to buy and sell fractional shares also make stock splits a moot point but we’ll save that for another piece! However, if you are just starting to invest – and don’t have access to fractional shares – then the share price really does matter.
For instance, if a $2,000 account buys 1 share of Widgets, Inc. the account is 25% invested in one company. However, after the split, you can buy a single share and only have roughly 6% of your capital tied into a single company. The thing to remember is that 1 share after the split, is worth 25% of 1 share before the split. The lower stock price may mean that smaller accounts will purchase more of the shares which creates demand for the stock which could raise the price. But again, the pizza didn’t get any larger, it just got cut into more pieces.
So perhaps both answers can be right. Though a stock split is a non-event from an earnings or valuation standpoint the smaller share price allows more individuals to purchase shares who otherwise may not have invested that much money in a single company. Either way, it is good to know the basics of stock splits… and good luck getting pizza off your mind!
Maple Capital Management, Inc. (MCM) is an independent SEC Registered Investment Advisor with offices in Montpelier, Vermont and Atlanta, Georgia. This commentary reflects the views of MCM and should not be considered to be investment or financial advice. MCM does not warranty these views and will not update this communication after the date of publication. Any mention of specific securities is done for illustrative purposes and the securities mentioned may or may not be held in client accounts. No assumption or assurance should be taken that securities mentioned will be safe or profitable investments. For further information, please contact Steven Killoran at 1-802-229-2838 or at [email protected]. For further information about Maple Capital, including a copy of our informational brochure, please visit our website at www.maplecapital.com.