Let’s say you have 10,000 dollars in your brokerage account, and you don’t have access to fractional shares. You are researching for companies to invest in, and you find Amazon, one of the greatest companies in the world. Through some research, you find that they are one of the largest businesses globally, they have solid financials, and great leadership. Unfortunately, their charts signal that the current share price is around 3,000 dollars, which immediately closes your investment thesis as a share takes one third of your account.
Many of our favorite companies have high share prices; I mean, if the company is very successful, the share value will go up. This also addresses a problem where many think the cheaper the stock, the better it is. This only comes into play if the company is worth more than the current price but buying penny stocks and thinking you are set for the long-term isn’t the best approach.
This is where stock splits come in handy. Simply put, a company multiplies the current number of shares into a greater amount using a certain multiple, while also dividing the share price by that same multiple. This allows for the company to have a lower stock price, but the same inherent value as there are more shares now. Why exactly would a company do this? First, it allows for more inclusion, specifically in the Dow Jones Industrial Average. The Dow is price weighted, which means it can’t induct high priced companies as it would cause a massive shift in the index value. Secondly, it allows for higher liquidity, narrowing the bid-ask spread, and it can help companies who are looking to initiate buyback programs.
The second reason ties back to retail traders. With a cheaper price, retail investors can buy more shares now and have control over each position’s weight on the portfolio. We’ve seen many companies do this recently with a record number of retail investors entering the market, the most notable one being Tesla. Tesla announced a 5 to 1 split, which brought the price from 2,500 to 500, allowing many retail investors to enter. Apple did the same with a 4 to 1 split, and Nvidia announced on Friday that they will perform a 4 to 1 split. High priced companies like Amazon and Google are also looking into it, which is very promising. Do you want your company to perform a stock split?
I am not a financial advisor and my comments should never be taken as financial advice. Investments come with risk, so always do your research and analysis beforehand.