Stock Splits
A stock split is a change in share count, without altering ownership shares. If you are an Apple Inc. (NASDAQ: AAPL) stockholder, for instance, after Apple’s four for one stock split on August 31, you would own four times as many shares as you did on August 30, but so would everyone else in the company.
The Evidence: In one of the earliest empirical studies in academic finance, Fama, Fisher, Jensen and Roll looked at the effects on stock splits on stock prices in 1969 and found (not surprisingly) that, on average, they happened after big stock price run-ups and that the splits themselves create no additional run-up, at least in the aggregate. However, when the sample was broken down into companies that subsequently increased and decreased dividends, they found that stock prices rose after splits for the former and dropped for the latter.
Follow Tesla Inc. (NASDAQ:TSLA)
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In the decades since, there have been dozens of studies and while they generally find that split announcements are accompanied by small stock price increases, they disagree on the reasons. Some argue that it is because of post-split changes in liquidity, some posit that it is because splits operate as signals and some claim that they change value.
Value Effect: I pride myself on being creative in coming up with value effects for almost any corporate action, but I must confess that I am floored with stock splits. It is a purely cosmetic action, and the analogy that I would offer is that a pizza, sliced into six pieces, will not taste better and nor will there be more of it, if it is sliced into twelve pieces. Neither Tesla nor Apple become more valuable companies, because of their stock splits, because nothing fundamental has changed in either company, as a consequence of the split. In short, if you thought Apple was overvalued on August 30, trading at $500/share, you would still find it overvalued trading at $125/share, after a four for one stock split, since both price and value will be a fourth of what they were the prior day.In the decades since, there have been dozens of studies and while they generally find that split announcements are accompanied by small stock price increases, they disagree on the reasons. Some argue that it is because of post-split changes in liquidity, some posit that it is because splits operate as signals and some claim that they change value.
Gap Effect: There is an argument to be made that stock splits can operate as gap events, especially if a company is lightly followed and little attention is being paid to it, leading it to be under valued. The split, while just cosmetic, can bring the company (at least briefly) into the news and that attention may be sufficient to causing the gap to close, by pushing the price towards value (which remains unchanged). This argument does not hold for Apple, the most highly valued company in the world, and Tesla, a company that clearly has never had a problem with attention seeking, but it could be used by a company like Marten Transport, which announced a 3 for 2 split on July 17, 2020, after seeing its stock price stagnate for a three year period.
