Why Do Companies Split Their Stock?
Price per share for Apple and Tesla reached a high of $505.76 and $2,318.50 respectively on Friday, August 28. The very next trading day, Monday, August 31, the share prices for these two companies reached a low of $126.00 and $440.11. That represents a drop of 75% and 81%. How come we didn’t hear about that decline? A similar phenomenon happened in June 2014 when Apple’s price per share went from a high on June 6 of $651.28 to a low of $91.75 on June 9—a price drop of 86%.
Well, the value didn’t drop. The title of this article gave it away. Both companies split their shares on that weekend. It was Apple’s fifth time of splitting its shares since it went public. This round, Apple split 4:1 and Tesla 5:1. In 2014, Apple split its shares 7:1. That means that the companies distributed the value of one share across several shares. For example, in a 4:1 split, a person who owned one share on Saturday, now owned 4 shares on the following Monday. Each individual share is worth less, but the four shares together should be close to Saturday’s value.
It’s like a baker offering you a chocolate cake for $100. You may say, “No matter how tasty that cake is, I will not pay $100 for it.” The baker then cuts the cake into ten pieces. Now you can buy a slice for only $10. That’s a lot more affordable than the $100 cake. But the slice is only 1/10 the size of the cake. In the end, you get the same value.
As a direct consequence of Apple's stock split this year, its influence on the stock market decreased. We'll discuss why later in this article.
So why do companies split stocks? The simple answer is that they want to boost the price. But why would a stock split boost the price? Here are some possible reasons:
1. Make shares more affordable
In theory, a stock split will make a company’s shares more accessible to a larger number of investors. With the cake example, the hope is that more people will buy the cake because smaller pieces are more affordable than a larger piece. The expected increase in demand could drive the price higher. Making shares more affordable doesn't just benefit the smaller investors. According to The Wall Street Journal, many institutional investors prefer to buy blocks of shares, such as 100 shares at a time. If the share price gets too high, those blocks may no longer be economical. Even though some retail brokers allow investors to buy a fraction of a company's share, you don't end up owning that share. Instead, the broker does.
2. Increase numbers of shares
The more shares there are, the more investors can buy into the company. Psychologically, it feels better to get 7 shares instead of one for the same price. That improved feeling may also drive more investors to buy the shares.
3. Expectation of Growth
Announcing a stock split is an effective marketing tool to bring a company into the headlines and create growth expectation. After all, why else would a company split its stock unless it planned to expand? That growth expectation can drive increased demand, which drives up the price.
4. Get into Dow Jones
Being part of an index can be good for a company. When a stock becomes part of an index, all the investment funds that copy that index now must buy shares of that new stock. That means increased demand for the stock, which tends to drive up the price. But why would splitting a stock help with getting into an index?
The Dow Jones Industrial Average index (“Dow Jones”) uses a different approach to calculating its value than most other indices. The editors of the Wall Street Journal subjectively decide which 30 companies become part of the Dow Jones. They then calculate the value of the Dow Jones by adding up the current share prices of each of the 30 chosen companies and then dividing the total by the Dow divisor. The Dow divisor gets changed regularly and is not a fixed number.
The larger the share price of a company, the bigger the impact on the Dow Jones if the company’s value changes. Therefore, having a company with a high price per share in the Dow Jones can increase the volatility of the index. To boost a company’s chances to get picked by the editors of the Wall Street Journal, that company may want to decrease its price per share. A stock split accomplishes that objective.
For example, in 2014, before Apple split its stock, The Dow Jones companies with the highest per-share-price as of June 6, 2014 were the following:
Now compare these prices to Apple’s $651 per share price at the time. Apple’s price fluctuations would have dominated the Dow Jones. By splitting its shares, Apple’s price dropped to $91.75 per share. Not too long after the split, Apple was added to the Dow Jones in early 2015.
Did it work?
Apple’s stock split in 2014 worked. Here are the effects on the value of Apple:
Source: GoogleFinance (6/19/2014); Disclaimer: Past performance is no indication of future results.
This year, Apple announced its planned split on July 30. Just like the previous split announcement, it drove the stock price up:
But the split itself hasn’t had the same effect as the announcement. We’re only looking at a couple of weeks since the split, but so far, the share price has been going down:
Stock splits aren’t always successful, but the announcement alone can drive the price up. Aside from potentially affecting the price, a split can have other consequences. According to The Wall Street Journal, "Apple’s influence on the Dow [Jones shifted] from being the most consequential to the middle of the pack" because of this year's split. Whether that change will increase or decrease the growth potential of the Dow Jones remains to be seen. But had Apple split its shares a year ago, the Dow Jones would be down even more year-to-date.