Stock splits usually generate strong returns.
Earlier this year, NVIDIA made waves when it announced a 10-1 stock split. At end of trading on June 7, 2024, every shareholder received nine additional shares for each share of NVIDIA stock they owned. The company had seen its stock soar to more than $1,200, potentially locking out new investors. Post-split, this price came back down to Earth, with NVIDIA trading at $129 per share post-split, making it easier for retail investors and employees alike to invest.
While a stock split doesn’t theoretically change the value of a company, it does have the ability to affect stock performance and volatility. As the name suggests, a stock split is when a publicly traded company increases the number of share in circulation. Typically the purpose of this is to reduce the price of the stock, to boost trading and make it more affordable for new investors.
Historically this has been successful. In general, after a split, a stock will significantly outperform the S&P 500 in the coming year. Research on this issue has been surprisingly durable, finding that for the first 12 months post-split a stock generally posts annual of around 25% to 30%.
This compares very favorably with the S&P 500’s average annual return of around 10% to 12%. Here’s what you should know.
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What Is a Stock Split?
A stock split is a way for a company to influence its share price, accessibility and trading volume.
In a general sense, high stock prices are good for a company. Valuable stock generates wealth for the company’s investors and gives the company access to investment capital by selling more of its own shares.
However, if a company’s share price gets too high it can start dissuading investors. In part, this is because of sheer expense. More investors can afford to buy a stock for $10 per share than for $1,000 per share, for example. This is particularly true among individual investors. So if the price gets too high, many investors may seek less expensive options, hurting the stock’s liquidity.
A split is a decision by the company’s leadership to increase the number of shares in circulation in an effort to boost liquidity and investments. The company will announce a ratio for the split, say 2-1 or 3-1. The company will then issue new shares of stock to each shareholder based on this math. When it does, the share price is divided by the same ratio. Each investor’s overall stake in the company remains the same, since they own more shares even though the stock is worth less.
For example, say that you own 100 shares of ABC Co. at $500 per share. Your overall stake is worth $50,000. In an effort to boost liquidity and bring in new investors, the company announces a 2-1 stock split. This means that ABC Co. will issue to all shareholders one additional share of stock for each share they currently own, doubling the number of shares in circulation while halving the price. After the split, you will own 200 shares of stock at $250 per share. Your overall stake will still be worth $50,000.
“A stock split is generally viewed as a positive development for shareholders because it increases liquidity and makes shares more accessible to a broader range of investors,” said Robert Hodgins, Founder of Sand Hill Road Technologies Fund. “However, it’s essential for investors to recognize that while a stock split may reflect strong past performance, it doesn’t create any intrinsic value and should be evaluated in the broader context of the company’s overall financial health.”
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How Does A Company Perform Post-Split?
Historically, stock splits tend to be good for share prices.
“Typically in the 12 months after a stock split, the stock that has split outperforms the market,” said Matt Willer, a partner with the financial firm Phoenix Capital Group.
By reducing prices a stock split makes investing in the company more attractive, he said, especially to ordinary investors. “This tends to stimulate more buying and hence appreciation. However the pure act of a split does nothing inherently other than dividing the shares by a factor and reducing the price per share by that same factor on the day of the split. While it’s largely optics, the investor psychology is well defined and has demonstrated outsized returns post split.”
On average, a stock will grow by between 25% and 30% in the first 12 months after a split. This compares very favorably with the S&P 500’s average growth of between 10% and 12%. Much of this, as Willer said, comes from both the interest generated by a stock split and the greater accessibility of a lower price.
Take Apple for example. The company issued a 4-1 stock split on August 28, 2020. This reset the share price to $124. By August 27, 2021 Apple’s stock had risen to $146, a 16% return.
Now, this isn’t always the case. Consider Tesla, for example. On August 24, 2022 Tesla issued a 3-1 stock split. Shares traded for $288 per share at the time of the split, but had fallen to $238 per share by August 25, 2023, an 18% loss. Or take Amazon’s noteworthy 20-1 stock split on June 3, 2022. At the time of the split, Amazon’s stock traded for $122. One year later, it traded for $124, slightly under 2% returns. So, while splits often generate significant growth, there are no guarantees. A financial advisor can help you evaluate individual businesses for investment purposes.
The Bottom Line
A stock split is when a company increases the number of shares it has in circulation, distributing new shares to investors proportional to the number they currently hold. This reduces the stock’s price without changing its market capitalization, potentially making the stock much more accessible.
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