Amidst the continuing tech stock sell-off, e-commerce leader Shopify (SHOP -2.37%) made headlines last week as the latest tech giant to announce a stock split. Apple and Tesla both completed stock splits in 2020, while semiconductor giant NVIDIA completed its own split last year. Even more recently, FAANG giants Alphabet and Amazon both announced stock splits, which are scheduled to occur this summer.
Per the terms of Shopify's proposed 10-for-1 stock split, investors would receive an additional nine Class A or B shares for every one share they hold. However, Shopify CEO and founder Tobi Lütke would receive a special "founder share," effectively giving him total voting power of 40% when combined with his existing Class B shares. Shareholders are set to vote on the stock split on June 7.
Should shareholders vote in favor of the proposal, investors could benefit from short-term momentum leading up to the split. However, it may be in the best interest of investors to hold throughout the short-term volatility in order to maximize gains. Let's review what a stock split means and take a look at what splits have historically done for investors.
Benefits of a stock split
In a stock split, companies increase the number of shares outstanding, which subsequently decreases the share price by a proportionate multiple. Effectively, the market capitalization of the company is engineered to stay the same. However, recent examples show that stock splits often lead to an increase in the valuation of the company because shares appear less expensive than they really are, thereby fueling demand from investors.
Over the last two years, investors have witnessed abnormally high pricing across asset classes due to a number of factors. Things such as meme stocks, popular demand in trading apps like Robinhood, and the rising adoption of cryptocurrency have all contributed to inflated valuation multiples. As a result, stock prices have risen sharply, which can make some investors uneasy.
If a stock has experienced a dramatic run-up, especially compared to similar companies, it is not uncommon for investors to begin asking themselves when the music will stop. In an effort to prevent massive sell-offs and to market shares to a broader range of investors, company leadership may opt to split the stock. This is because the shares will look cheaper, so less sophisticated investors often begin accumulating shares in large volumes. Subsequently, the trading liquidity of the stock increases.
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Buy now, or buy later?
Recent stock splits from other major tech companies offer some insight into how a future split may impact Shopify investors. Apple, for instance, completed its last split in August 2020. Following the split, Apple stock closed at roughly $129 per share. But about one month later, Apple stock declined by 10%. If investors held Apple stock over the past 18 months, they would have appreciated an overall return of 27%, as Apple's current stock price is around $164 per share.
Tesla also happened to complete a stock split in 2020, on the same day as Apple. Immediately following the split, Tesla stock closed around $498 per share on a split-adjusted basis. But Tesla stock experienced the same phenomenon as did Apple: following the split, Tesla stock decreased by 14% and closed around $429 per share. If investors held Tesla stock through this short-term volatility and momentum trading, they would have earned a 99% return, as Tesla now trades at roughly $989 per share.
The common denominator is that the stock price has typically increased in the long term and exhibited resilience despite short-term momentum traders buying and selling in and out of the stock around the time of the split.
Keep an eye on valuation
Between January 2020 and December 2021, Shopify stock increased by a whopping 244%. But despite this performance, the company was not immune to the broader tech stock sell-off, which hit growth companies especially hard. On a year-to-date basis, Shopify stock is down nearly 60% at the time of this writing. This translates into a current price-to-sales ratio of 16, compared to 53 in June 2021. Although it can be challenging to buy a stock as its price continues to decline, history shows that valuations often rise significantly in the long term following stock-split events. Now may be a good time to buy Shopify stock as it hovers around 52-week lows and before it possibly rises should the split be approved.
