Several big companies are announcing stock splits, including Tesla, Amazon, Alphabet, and Shopify. Investors seem to love them, and they certainly generate headlines for the companies doing them.
One company that could soon join the ranks of recent splits is big-box retailer Costco Wholesale (COST -0.24%), which hasn't split its stock since 2000. I'll explain what stock splits do and don't do, and look at why a stock split could make sense for Costco.
So what exactly happens when a stock is split?
Stock splits are exactly what they sound like: A company splits its stock to create more, less costly shares. Suppose you are a company with 100 shares trading at $10 each. Your total company stock would be worth $1,000 (100 x $10).
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Now, you decide to do a 2-for-1 stock split. In this case, your company's stock would become 200 shares, creating two shares for every single share. If it were a 10-for-1 split, your 100 shares would become 1,000 shares, and so on.
The crucial thing to remember is that the company doesn't become more valuable from a stock split. The company's shares will add up to the same valuation, no matter how many shares the split creates. So if there are 200 shares, they would be priced at $5 each, adding up to the same $1,000 total value. Think of it like cutting a pie into more slices: The pie doesn't get bigger; the pieces get smaller.
How stock splits can help investors
If stock splits don't do anything for the company, why do investors like them? While some investors might mistakenly assume that the split makes the stock's valuation cheaper, a split does has some potential benefits.
The stock's valuation might not change for starters, but the lower share price does help retail investors accumulate shares. Not many investors can afford to buy very much stock when a company is trading at $3,000 per share, but when that's broken up into smaller pieces, it's easier for retail investors to feel like they're building a position.
Having more lower-priced shares on the market makes the stock more liquid, making the share price itself more consistent. A stock that doesn't have much liquidity, meaning that it's hard for buyers and sellers to trade shares, might be more vulnerable to large zigzags in the share price.
Why Costco could be next
Wholesaler Costco has been a home-run investment over the years, up 1,100% since the last time the company split its stock in January 2000. At almost $600 per share, the price is getting large enough to give smaller investors who want to buy and hold the stock a hard time building a position.
More importantly, a company shouldn't split its stock for publicity or headlines; it should be a thriving, growing business, and Costco is just that. The company has grown revenue by an average of 8% annually over the past decade, and its earnings per share has grown 13% per year at the same time. If the company keeps growing at this pace and the stock's valuation remains the same, the share price will double to almost $1,200 over the next five to six years.
Years of consistent growth (strong fundamentals) will typically boost your share price if you give it time, so after 20 years of solid returns, it might be time for Costco to make its stock more affordable for retail investors.
