GameStop (GME -4.95%) wants to split its stock for the first time in 15 years. While many were caught off guard by the video game retailer's announcement, some investors were also confused because it wants the split to be "in the form of a stock dividend."
Everyone is familiar with cash dividends -- a company pays you money every month, quarter, or at some other frequency to own the stock -- but not so much a stock dividend, even though most companies describe their splits as a dividend.
Tesla (NASDAQ: TSLA), for example, also recently announced that it wants to split its stock in the form of a stock dividend. But many internet stock traders seem to think that because GameStop has a high percentage of shares sold short, the language has special significance.
So does it matter that the video game retailer will split its stock as a dividend, or is this really just boilerplate and much ado about nothing?
Buying into the meme stock frenzy
Because GameStop was one of the first meme stocks and continues as one today, its stock rarely trades on its fundamentals. One of the hallmarks of meme stocks is their share price tends to move more in relation to chatter on internet stock boards and social media than on what its business looks like.
GameStop became a meme stock poster child a year ago because chat room discussions rallied individual retail investors behind its vastly shorted stock. Believing they could initiate a short squeeze by buying the stock and causing its price to rise, hedge funds and other short-sellers would be forced to cover their positions. And they were right.
Shares of GameStop soared as high as $483 a share last January but had fallen back to around $80 a share last month before a new rally caused them to double in value, at which time the retailer announced plans to split the stock.
GameStop's stock remains heavily shorted, with more than 26% of its float sold short. But that's far below the level it stood at a year ago, when the short sellers overplayed their hand and sold more shares short than were in circulation. According to financial analytics firm S3, short interest in GameStop reached as much as 141.8% of its float at its peak on Jan. 4.
As GameStop bulls piled into the stock, buying up its shares or stock options, which caused market makers to buy the underlying stock, few if any shares were left available for shorts to cover their position, and the stock rocketed higher.
Playing the short game
But GameStop's stock split isn't likely to affect short sellers. While shorts would be required to pay a cash dividend if GameStop issued one, a stock dividend works pretty much the same for all investors regardless of whether you're short or long. The effect is to increase the share count and lower the share price using the split ratio.
For example, an investor with 10 shares of stock trading for $100 that splits 2-for-1 will now own 20 shares, but they will be worth $50 each. A short-seller who shorted 10 shares will have to buy back 20 shares after the split, but also at $50 apiece. There are no extra shares to pay back because it's a "dividend."
In fact, the dividend aspect of the split only affects the company's accounting -- basically how much it keeps in its retained earnings account -- and not much else. By declaring it a stock dividend, GameStop's cash balances won't be affected by it as they would be with a cash dividend, and the stock split won't trigger a new "gamma squeeze" on its shares.
Ready to roar?
Stock splits are seen as bullish signs from a company, and studies show stock prices tend to rise after the announcement as well as after the split happens, even though nothing about the company changes.
It may or may not be notable that GameStop's stock is down by more than 12% since the announcement, but investors should still consider the fundamentals of the company before investing, because it can't trade on hype forever.
I still wouldn't short GameStop's stock, because, as economist John Maynard Keynes is reported to have remarked, "The market can remain irrational longer than you can remain solvent." But that doesn't means the stock is a buy, either. And certainly not because GameStop is splitting its stock.