Shares of Nvidia (NVDA 4.43%) have soared since the company reported a strong first-quarter earnings report on May 22 and announced a 10-for-1 stock split.
Since then, the stock has jumped roughly 20% in less than two weeks, and its momentum seems to be continuing into the stock split, which is scheduled to go into effect after hours on June 7. Shares have climbed nearly 10% after the initial bounce on those announcements.
There are a number of reasons investors are reacting favorably to Nvidia's upcoming split. First, even though stock splits don't change the fundamentals of a stock or the business, investors seem to believe that splits are a positive sign from management that it expects the share price to keep moving up.
A stock split also acts as a reset for the share price, effectively signaling that it has reached a certain milestone and is ready to run up again.
Splits also make individual shares cheaper, leaving them more accessible to retail investors, which can help boost demand. And there's also evidence that stock splits are correlated with outperformance over the next year, which could be due to a combination of both the momentum in the business that led to the stock split in the first place and enthusiasm from investors resulting from the split.
However, in the case of Nvidia's upcoming split, there's an added reason investors have become even more bullish.
Some investors believe that Nvidia could replace Intel (INTC +0.30%) in the Dow Jones Industrial Average (^DJI 1.05%), fully establishing it as a blue chip tech stock.
Image source: Getty Images.
Why Nvidia isn't in the Dow yet
The Dow Jones is a price-weighted index, which means that the degree to which each stock impacts the index is based on its share price. That's an important difference from the S&P 500 and the Nasdaq indexes, which are weighted based on market cap.
If Nvidia were to be added to the Dow at its pre-split share price, it would have by far the highest weight and distort the index, which is based on 30 blue chip stocks from diverse industries and meant to reflect the broad market.
However, the stock should have a share price of around $110 to $120 after the split, which puts it near the median price of current Dow companies.
Why Intel could get booted from the Dow
There aren't strict criteria for stocks to be admitted or kicked out of the Dow Jones, but according to S&P Global, which manages the index, a Dow stock should be a blue chip company; have an excellent reputation, sustained growth, and wide investor interest, and contribute to sector balance.
At this point, it's fair to question Intel's ability to deliver sustained growth because it has long been a laggard in the semiconductor industry. Over the last decade, the stock has gained just 11%, trailing the Dow Jones by a wide margin, and Intel hasn't posted a quarter with double-digit revenue growth in nearly four years even as peers like Nvidia report much faster growth.
The last stock to be removed from the Dow Jones was Walgreens Boots Alliance, which came after several quarters of underperformance and weak results, similar to what Intel has been experiencing.
If Intel were to be dropped from the Dow, Nvidia would be a logical replacement -- both stocks represent the semiconductor industry. Nvidia is also now much larger than Intel, with a market cap of $2.8 trillion, compared to Intel's $129 billion.
NASDAQ: NVDA
Key Data Points
What joining the Dow would mean for Nvidia stock
Being admitted to the Dow likely wouldn't have a huge effect on Nvidia's stock price. Unlike the S&P 500, the Dow isn't widely tracked by ETFs, meaning that investors don't generally invest in it directly the way they do with the S&P 500.
In fact, only one ETF, the SPDR Dow Jones Industrial Average ETF, offers a way to get direct exposure to the Dow Jones index and only the Dow Jones.
Still, it would be a psychological win for Nvidia to gain entry to the hallowed blue chip index. And it would make sense because Nvidia is now the third most-valuable company in the world -- and the most valuable not to be included in the Dow because both Apple and Microsoft are members.
It would also act as a stamp of approval from the committee that Nvidia's success isn't seen as a fleeting phenomenon or a bubble.
At the same time, removal would be the latest setback for Intel, but it seems to be deserved, given its long-term underperformance. At this point, there are clearly better representatives from the semiconductor industry to include in the index.
Reviews and rebalancing are rare for the Dow Jones, but it makes sense here. Don't be surprised to see Nvidia replace Intel in the Dow Jones Industrial Average once the stock split goes through, though the timing of such a decision will remain a mystery.
