As a finance guy by training, I've always been fascinated by stock splits, such as the incredibly-rare seven for one split Apple announced yesterday. First off, just how rare is a seven-for-one split? Incredibly rare; since 1980, there have been only three splits bigger than that; all were ten-for-one splits.
By the books in Finance, a stock split adds no value to a person's shares, because it's simply a redivision of their current holdings. Consider someone holding 100 shares of Apple at yesterday's closing price of $524.75 per share:
- Pre split: 100 shares * $524.75/share = $52,475.00 value
- Post split: 700 shares * $74.9643/share = $52,475.00 value
The Finance books look at that, and say "no change in value, ergo, a stock split has no intrinsic worth." And they're right; there's been no change in value for any investor's holdings. But studies done over the years have shown that stock splits do have a positive impact on investor's holdings:
A 1996 study by David Ikenberry of Rice University measured the short and long-term performance of stock splits. His research included all the 1,275 companies whose stock split 2-for-1 between 1975 and 1990. Mr. Ikenberry compared the split stocks to a control group of stocks for similar-sized companies in similar sectors that had not split. His results were startling. The split stock group performed 8% better than the control group after one year, and 16% better after three years.
Why might that be? I'm sure the studies have detailed financial models to back up their findings, but to me, it boils down to two things…
- Perception: Companies don't split their stock when they're doing poorly. In fact, if things are going badly, companies are more likely to do a reverse stock split, bumping their share price by removing shares from circulation. (The above investor's 100 shares @ $524.75 would become 50 shares @ $1049.50 in a 1-for-2 reverse split, for example.)
So when a company announces a split, the perception is they're doing well, and their stock is a good investment. Hence, more people buy it, driving up the price, and creating real wealth increases (on paper, at least) for those holding the stock pre-split.
And if they announce something as rare as a seven-for-one split, well, the reaction seems to be fast and dramatic—Apple's stock increased over $40 a share (about 7%) overnight. (Apple also announced an expanded stock buy back program, which also helped.)
- Accessibility: As share prices rise, I think the pool of potential investors shrinks. Why? Consider someone with $1,500 to spend. At Apple's current share price, they could buy roughly three shares of stock. Mentally, three shares doesn't feel like all that much, and many would rather spend that $1500 on a company at $75 a share, so they own 20 shares. Yes, this is illogical as total returns will be the same for the same percentage change in price.
But with a lower share price, it's also possible to see bigger dollar swings in the share price: a 10% increase on Apple's current price is over $50 a share; a 10% increase on a $75 share is only a $7.50 move. So with a lower stock price, an investor can own more shares, and those shares are capable of making larger dollar-value changes. (A juicy-good rumor might send the stock up $7, but it clearly won't send it up $50.)
Consider the effects of that juicy rumor that sends Apple's share price up $7. If the investor owns three shares, they've made a whopping $21; but if they own 20 shares, that's $140.
Also consider someone with a very limited investment budget; they've got $250 to invest. That's not even a half-share of Apple, their favorite-ever company, at today's prices. But at $75, heck, they can buy three shares. Sure, not enough to get rich on, but enough to say they own some of their favorite company.
So the lower share price means that investors can own more of the company's stock, and that those shares may be more able to increase in actual dollars than a higher-priced stock. Owning more shares, and having those shares move farther and faster are good things. This increases demand for the stock, driving up the price. And a price increase means real (paper) wealth increases for those holding pre-split shares.
What do those two reasons have in common? Both are completely illogical when viewed from the perspective of a Finance textbook. There's nothing that ties a stock split directly to a company's performance, and there's no technical reason why owning three $500 shares is any different than owning 20 $75 shares. But as history has taught us, the market doesn't really care about logic and book learning.
Given all of the above, it will be interesting to see how Apple's stock price moves between yesterday's $524.75 close and June 2nd, when the split takes effect. As I write this, the stock is still trading up nearly $40 a share, so it's held onto most of its overnight gains.