How Do Companies Decide When to Split Their Stock?

After many long years immersed in the markets, we at The Motley Fool can tell you that sometimes, stock prices are just weird. (That's a technical term.) For example, splitting a stock should have as little effect on the value of the company as cutting a cake should have on the calories -- but maybe there's more to it.

In this segment from MarketFoolery, host Chris Hill and Motley Fool Asset Management's Bill Barker respond to a listener's question on the subject, digging into how stock splits can sometimes position companies and investors to reap mild non-illusory benefits. Here's why businesses do them.

A full transcript follows the video.

This video was recorded on Aug. 27, 2018.

Chris Hill: From Jerry Villani in Cleveland, Ohio. Jerry writes, "I'm looking at my shares of Amazon (AMZN -1.14%) at nearly $2,000 a share, and I started thinking about stock splits. I know it doesn't mean anything on paper, but it does seem that a share price of $100 would make the stock more accessible to more investors, thus creating more demand and moving the price up. What goes into the thought process of companies when deciding to split their stock or not?"

Great question. He's talking about Amazon, he could very easily be talking about Priceline, AKA Booking Holdings. Last time I checked, that stock was somewhere in the neighborhood of $2,000 a share. This was an issue with Apple a couple of years back when they decided to, if I'm recalling correctly, split their stock 7:1. It seems like at least part of the calculus there was, "This will get us into an index or two."

Bill Barker: I think that, of course, stock splits are a lot less popular today than they used to be 10, 20 years ago. Stock split announcement back in the late 90s was enough to goose your share price. It was an indication, seemingly, of optimism about the future of the company.

So, what actually goes in. Going back to making it easier for shareholders to buy, I think that was a very common and consistent rationale with reality back in the day. That is, companies knew that brokers tended to recommend that shares be bought in lots of 100. So, they would attempt to keep their price -- depending on the stock and the industry -- at something that was affordable in lots of 100 shares. So, $20-40 was a pretty common stock price. Companies would split to be in that range. I think nowadays, where there's a lot more use of electronic investing -- almost total use of it, and people can just look at their accounts and say, "I need eight shares, or 15 shares," it's easy to do and you get the same price. So, people are more comfortable with buying stocks that have much higher prices. It is true that, for a couple of thousand bucks, you just simply can't buy it if you're just looking to make a $200 purchase or a $1,000 purchase.

I don't think that there's any lack of demand for Amazon. I mean, to use Amazon specifically, there seems to be plenty of demand enough...

Hill: For the stock?

Barker: For the stock. They don't need to split the stock. I also think that the example of Berkshire Hathaway, largely, has given many of these companies -- like Alphabet and Amazon -- a leader to follow, and a demonstration that you do not need to split your stock in order to keep people interested in it.

Hill: They sure are fun, though. I mean, wouldn't it be fun, if you were an Amazon shareholder, to be like, "They're splitting it 10:1." There's just something, on a gut level -- I know, I know how the math works. [laughs] I know it's simply cutting the pizza into 16 slices instead of four, or whatever it is. It doesn't change the size of the pizza. It's just fun!

Barker: I can remember being at a meeting with management of a company that had been recommended in the Hidden Gems newsletter back in the day. I was there with Bill Mann and Tom Gardner. The stock had recently split, or an announcement that it was going to split had recently been made. We asked, "Why'd you do that?" And management said, "One of the reasons was that the employees who are getting options just like to see a bigger number. They'd rather see that they're getting 100 shares this year instead of 50." He said, "I know that sounds dumb, but that's one of the reasons why they did it." I think that gets to the fun. More seems more fun. It's just a psychological thing, I guess, which is true, but not helpful to shareholders.

Hill: It is not helpful. Of course, the flip side of that is the case for penny stocks. As much as anything, that is probably the No. 1 bull case for penny stocks. "Look at how many shares you get!" [laughs] It's not, "Look at this great business!" It's, "This thing's trading at $0.20 a share! For $100, look at how many shares you get!"

Barker: I think that the days of a lot of stock splits seem to be over. I don't know. They could come back in vogue. Things go out of style and come back in. But most of the companies that you most respect, in terms of their market capitalization and recent stock performance, run into the hundreds, and now occasionally thousands, of dollars per share. And they are suffering no ill consequences of that. I think that it has a lot to do with electronic trading and the ability to just buy seven shares of an expensive stock.