Does a Stock Split Matter?

by JT McGee

In a word, unfortunately, yes.

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.

{ 6 comments… read them below or add one }

William @ Drop Dead Money February 28, 2013 at 10:20

You’re right — a price split shouldn’t matter, but it will, although not in a major way. I’m thinking Apple management has to feel out of sorts that their stock has a PE of only 10 or so. Maybe a stock split can do something about that by putting the stock within reach of their fanboys, the ones who vote their wallets with their hearts, not their heads…

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JT McGee March 1, 2013 at 14:18

At the current price it doesn’t seem that any one is thinking with their heads. Apple is trading at the kind of multiple that I like to pay for NO GROWTH companies. Seeing as it has at least high single digit growth ahead (my guesstimate) it looks like a great deal. If I didn’t have a “no technology” rule, I’d probably own it.

Apple definitely needs the fanboys to get in on it. Anything to fix that languishing stock price.

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Wayne @ Young Family Finance February 28, 2013 at 22:23

There is something to attracting retail investors. I remember when I first wanted to try out my own diversified portfolio, I was trying to pick 20 stock with $12,000. It would have been hard to include Apple in my portfolio at the time.

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JT McGee March 1, 2013 at 14:19

Wow, 20 stocks with $12k?

That’s exactly what I’m talking about, though. I think the optimum share price for maximum participation and cost minimization has to be sub $100/share.

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My Financial Independence Journey March 1, 2013 at 15:03

If Apple does a 10:1 split, there will be a mad rush into the stock. Because people are crazy. But I think that the downward trend of the company will continue. When your business model involves creating highly innovative products in entirely new spaces, that can’ be sustained forever. Apple may have revolutionized the smartphone and the tablet, but I’m not confident that they can maintain their market share and keep charging the prices they do as these products become commodities rather than luxuries.

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JoeTaxpayer March 2, 2013 at 23:20

You mentioned the options. The market has priced a return to $600 in the next two years as a 4 to 1 event. A split would split the options as well, of course, and the move from 45 to 60 seems far less improbable than 450 to 600 even though the increase is identical.

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