Rainmaker

What is a stock split & why is everyone doing one?

Not all splits are bad. Remember the time you were pillow fighting with your ex & she decided to crank up a chainsaw & chase you around the house? That’s a good split. It was never going to work out – trust us.

With Apple & Tesla recently announcing stock splits, does it change how much you own? What happens to the stock price? Why do a stock split? We have you covered.

If your entire stock is a pizza, a split is just dividing it into slices, it’s that straightforward. The overall size of the pizza stays the same. Here’s a quick example:

– You own one share of BankerX stock worth R1,000

– BankerX announce a 5 for 1 stock split

Basically it means your one stock (worth R1,000) gets sliced into 5 pieces of R200. Your actual shareholding % doesn’t change. The pizza you own is still the same size. 

Why do a stock split? Consider an extreme example – Warren Buffet’s Berkshire Hathaway Class A shares are priced at $320,000 EACH! Most people don’t have $320k lying around so a stock split allows for increased liquidity and improved retail participation. Simply put, it allows an investor with limited capital to get involved and participate in the market. 

Of course this becomes less of an issue these days since most brokers allow fractional ownership & ETFs where you can replicate the exposure through a synthetic/ constructed product. For people who want to actually own 100% of the underlying stock – a stock split makes this much more appealing.

Textbook finance will tell you the stock price post a split should result in a marginal uplift (if any) resulting from increased retail participation. Except a finance textbook in 2020 is as useful as chocolate teapots. Here’s Tesla’s stock price surging on news of the stock split encouraging retail participation.

 Stock splits increased liquidity (more shares trading) but the potential downside is always higher volatility. One of the reasons Buffet has maintained the decision not to split Berkshire Class A shares.

“I think most people think that the stock would sell for more money post-split. We wouldn’t necessarily think that was advisable in the first place. In the second place, we don’t think it would necessarily be true over a period of time. We think our stock is more likely to be rationally priced over time following the present policies than if we were to split in some major way. And we don’t think the average price would necessarily be higher. We think that the volatility would probably be somewhat greater, and we see no way that volatility helps our shareholders as a group” 

– Warren Buffet

So the next time you log onto your trading app & see the stock price down 80% – here’s hoping it’s due to a stock split… & not bankruptcy. 

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