You’ve probably heard about the rumored Apple share split that would split existing shares by 10. That is, those who own an Apple share currently worth about $450 would instead own 10 shares worth $45 each. The whole of the company would be represented by 10 times and many shares, and thus each share would have 10 times less value.
Can splits create value?
Theoretically, a stock split should result in no change in the underlying valuation of a business. If a company has 100 shares worth $10 each, it is worth $1,000, just as it would be if it had 1,000 shares worth $1 each.
Of course, this ignores a common illogical thinking pattern in the retail investor, people who buy and sell stocks on their own – people like you and I and the guy you know who watches too much CNBC.
Retail investors often shy away from stocks with expensive per-share prices. At $450 per share, one Apple share is a fairly large amount of money for a guy toting a $10,000 trading account. At the margin, a lower share price may encourage more ownership of Apple shares among retail investors.
For example, if you wanted to put 10% of your $10,000 portfolio in Apple, you’d really only be able to hit 9% (two shares worth $900) or 13.5% (three shares worth $1,350). A high share price creates rigidity for small time investors.
Keep in mind Facebook probably wouldn’t have had an IPO at nearly the valuation it did if it had 100x fewer shares and priced each share at $3,800 instead of $38. Retail participation matters; the stock was priced to entice people who know more about Instagram filters than the time value of money.
And let’s not forget options…
A split also creates a much more liquid market for stock options. Options are traded in lots representing the right to own 100 shares at a given price. An options lot for 100 shares of Apple is basically like having exposure to $45,000 of Apple shares at the current price.
If Apple were to enact a 10:1 split, then each options contract would be equal to controlling something like $4,500 of Apple, which is obviously more manageable.
Basically, as units get smaller, the granularity does too. And, as the units get smaller, more shares or options can be held at the margin, which can have a very modest effect on stock prices.
Back to Rationality
At the margin, new shareholders really aren’t worth all that much. Actually, companies hate it when someone owns one or two shares, because then they have to send you dividends and mail you proxy information, letters, or whatever they do for shareholders of record. It depends on the company, of course, but at a minimum they have to mail you proxy information occasionally.
And that can get expensive. Actually, a lot of small cap companies deliberately try not to have many shareholders. They may do odd-lot tender offers to buy up the shares from people who have a very minor investment in the company, or pay special one-time dividends just to “find” long lost shares that people forgot they owned. Yes, shareholders get lost, too. Paying a one time dividend is a great way to get people to notice that they own shares of a stock they forgot about 20 years ago.
So, increasing the share count to increase the number of shareholders can actually be costly. But it can create a short term bump in the stock price.
All else being equal, it really does not matter for long-term holders. However, if Apple were to suddenly split their stock 10:1, I’d venture to guess you’d get quite a bit more retail investors hopping in to buy. It’s stupid, illogical, and completely backwards, but that’s just how the whims of the stock market work.
“You can’t explain that,” said Bill O’Reilly.