Alphabet (GOOG -0.45%) (GOOGL -0.51%), the parent company of Google, executed its 20-for-1 stock split on July 15. That represented the tech giant's second stock split after its 2-for-1 split in 2014, and reduced its trading price from about $2,200 to approximately $110 per share.
Many investors dismiss stock splits as meaningless, since they merely break single shares into smaller pieces. The company's market cap and valuations will remain unchanged, so it's not actually "cheaper" just because its shares are now trading at a lower price. If you pay a dollar for a single slice of a 20-slice pizza that originally cost $20, you're not getting a bargain. Fractional share purchases, which are now offered at most brokerages, make stock splits even less meaningful for most retail investors.
I discussed Alphabet's core business in detail last month, and concluded that its strong advertising business, inescapable digital ecosystem, growing cloud business, and low valuations still made it a great all-around investment, regardless of whether or not it splits its stock. But today I'll review three real reasons the split could change the market's perception of Alphabet.
1. More attention from retail investors
Stock splits don't alter a company's fundamentals, but a lower price could still attract the attention of smaller retail investors. The average size of a Robinhood account is only about $4,000, so Alphabet's trading price of more than $2,000 probably prevented many investors from buying the stock right away -- even though fractional purchases were always an option.
Some investors also likely believe that high-priced stocks have less upside potential than lower-priced ones. For example, it might be more feasible for a $2 stock to double to $4 than for a $2,000 one to hit $4,000. That logic is deeply flawed, because it doesn't take into account a company's fundamentals or valuations, but it's also why penny stocks are so popular. Therefore, Alphabet's stock split will likely cause its daily trading volume to rise.
2. More options for options traders
An increase in daily trading volume might not be meaningful for long-term investors, but it matters for options traders. A single options contract requires 100 shares of an underlying stock, so it can be prohibitively expensive to trade options in stocks that have high trading prices.
Prior to its split, a single options contract in Alphabet would have been pegged to $220,000 worth of shares. A person who owns just a single call option would need to set aside that much money to exercise that contract. After the split, a single contract is only pinned to about $11,000 in shares.
That change opens up significantly more options for smaller investors in the options market. Alphabet investors who didn't own more than 100 shares before the split (but now own over 100 shares post-split) can now write covered calls to generate additional income from their positions.
Bullish investors who didn't have enough cash to buy call options on Alphabet before can now buy calls on the post-split shares at a lower price. Those who are bearish on the stock can also buy more put options. Either way, that elevated options activity turns Alphabet into a more actively traded stock.
3. A possible inclusion in the Dow Jones Industrial Average
Lastly, Alphabet's price reduction could qualify it for inclusion in the Dow Jones Industrial Average. Alphabet was already added to the market cap-weighted S&P 500 back in 2006, but it hasn't been added to the price-weighted Dow Jones Industrial Average because its previous $2,200 price tag would have significantly inflated the entire index's value.
To calculate the value of the Dow, you simply add together the prices of the 30 stocks and divide the sum by the index's divisor -- which is being constantly adjusted for stock splits, dividends, and other events. At $110 per share, Alphabet has a much better shot at being included in that blue-chip index.
Being included in the Dow would automatically add Alphabet to any mutual funds or exchange-traded funds (ETFs) that track the index. As a result, more passive investments could flow into Alphabet -- even though plenty of funds and ETFs already hold the stock among their top holdings.
Microsoft notably joined the Dow on Nov. 1, 1999, and its stock has generated a total return of 775% since its inclusion. Apple replaced AT&T in the Dow on March 19, 2005, and it subsequently generated a whopping total return of 11,220%. An inclusion in the Dow doesn't guarantee those kind of returns, but it indicates Alphabet will remain a crucial cog of the U.S. economy for the foreseeable future.
Separate the hype from the facts
Alphabet's stock split won't magically make it a red-hot stock again, especially as rising rates continue to squeeze the tech sector. However, it also isn't as meaningless as some of the critics might claim. Investors should separate the hype from the facts to see if it they should pick up some post-split shares.