There has been some excitement in the stock market recently, as both Apple and Tesla have just split their stock -- 4-for-1 and 5-for-1, respectively. The excitement isn't exactly warranted, though, because stock splits are far less meaningful than you might think.
And don't believe everything you read about the companies and the splits, either, starting with eToro analyst Adam Vettese's suggestion that the shares may surge 33% higher post-split.
Image source: Getty Images.
Here's a closer look at stock splits in general and at Vettese's claim.
Stock splits, in a nutshell
Many people, consciously or subconsciously, associate having lots of shares of a stock with greater wealth. If Person A owns 100 shares of a stock and Person B owns 5,000 shares of a stock, it seems reasonable to assume that Person B's stake is worth more. But if Person A's shares are trading for $125 each, that stake is worth $12,500, and if Person B's shares are priced near $1.25 apiece, that stake is worth just $6,250.
Given all that, if you learn that a certain stock is going to split and that you'll suddenly own twice as many shares (a 2-for-1 split), or three times as many (a 3-for-1 split), or more, that can seem exciting and meaningful.
But imagine Scruffy's Chicken Shack (ticker: BUKBUK), trading at $120 per share, and executing a 2-for-1 split. If you own $100 shares pre-split, that stake is worth $12,000: 100 shares times $120 is $12,000.
When the stock splits, though, you'll suddenly own 200 shares! But they won't be worth $24,000, because with stocks splits, while your number of shares increases, the stock price decreases -- proportionately. So you'll end up with 200 shares of a stock priced around $60, for a grand total value of around... $12,000. See? Not much really happened.
Should you expect a 33% pop?
Now let's look at the suggestion that Apple and Tesla may surge 33% post-split. The analyst explained: "Tesla and Apple are already two of the best-performing companies on the U.S. stock market and all the evidence suggests their upcoming stock splits could act as a tailwind for the value of their shares."
His assertion was backed up by some reasoning and numbers from his eToro firm. (Note that the word "toro" means bull in Spanish -- and that someone bullish on a stock is optimistic about it.) eToro looked at 10 large companies -- including Amazon.com, Disney, and Microsoft -- that have split their stock in recent years. On average, each rose about 33% in the year following the split.
Image source: Getty Images.
That's great, but there are a lot of things to consider before you put too much stock in that:
- It's an average, so some stocks have risen much more and others much less than 33%.
- Relatively few numbers were crunched to arrive at that average. Three of the 10 companies have only split their stock once, for example.
- Amazon.com, which has split its stock three times, has risen an average of 209% in each post-split year. That's much more than all the other companies' averages, and it plays a large part in why the overall average is 33%. The next highest average is Microsoft, at 47%, and all the others are 25% or less, with two of the companies sporting negative average gains.
- Apple is among the 10 companies, and it has split its stock four times in its history, enjoying an average 10% pop per split, per eToro. That seems to suggest that, if anything, we might expect a 10% increase, not a 33% one.
- Both growth stocks have already been on a tear -- Apple has risen about 145% in the past year, and Tesla about 925% (almost doubling!) as of this writing -- so a further significant jump doesn't seem particularly called for.
Investing in businesses
Think beyond these numbers, too, to the businesses themselves. Remember that a share of stock represents a (small) ownership stake in it -- in a real business that's, ideally, generating revenue and earnings and growing those numbers over time. If you're expecting any stock to jump by 33% in short order, you have to ask yourself questions such as:
- Is the stock price undervalued? Will a 33% pop get the shares to a more reasonable level?
- Is the company growing so briskly that it warrants a 33% increase? Are revenue and earnings growing at a similar clip?
Much of this sort of discussion is kind of moot, anyway, if you're a good long-term investor, seeking to buy into high-quality businesses at good or great prices, aiming to hold them for many years, if not decades. That's how many people have built great wealth, after all.
A 33% increase doesn't seem like a gain you should particularly expect from either stock -- and in a relatively short period such as a year, anything can happen. One or both stocks might double from this point, or they might crash. The market might swoon again, too, taking both stocks down with it. (You should never put short-term money in stocks because of the market's volatility.)
In short, don't take predictions like the possible 33% gain too seriously. Focus on the businesses you invest in more than just their short-term price movements. Find the best companies you can with terrific long-term prospects and don't worry about what their stock prices will do tomorrow or next year.
And if it's all too confusing or stressful for you, do what Warren Buffett has suggested, and just use a low-fee, broad-market index fund to reach your investing goals.
