What is a stock split?

Donald Trump has officially started his second term as President. Trump is the second president, after Grover Cleveland, to serve two, non-consecutive terms. On tariffs, they were polar opposites. Cleveland wanted to lower protective tariffs at the end of his first term which hurt his re-election. Trump called for higher protective tariffs which probably helped his second election. Neat.

A forward stock split is when a company issues additional shares based on a set ratio. If a company performs a 2 for 1 split, they double the number of shares available. The price per share decreases by the same ratio. The main reason companies do this is to lower the price per share allowing more investors to purchase shares. 

There are also reverse stock splits where a company lowers the amount of outstanding shares to increase the price per share. A company might do this to ensure their price per share remains above minimum requirements for certain exchanges. To stay listed on the NASDAQ exchange, for example, companies' share price must be over $1.

When talking about stock splits, it is assumed to be a forward stock split. If the company is performing a reverse split, it will always be called a reverse stock split.  

In June 2024, NVIDIA share price was soaring past $1,200. If you are a retail investor wanting to join the fun, that is a high barrier to entry if you aren’t investing on a platform that lets you buy fractional shares of a stock. NVIDIA completed a 10 for 1 stock split which lowered the price to around $120 per share. If you owned 100 shares before the split, you ended with 1,000 shares. The value, however, remained the same… at least momentarily.

When a company announces a stock split, that signals to investors that the board believes the share price will continue to rise and a split is necessary. This good news leads to investors purchasing shares at the higher price. Then, after the split, investors who couldn’t purchase shares at the high price, now purchase shares at the new, lower price. All of this increases demand and price. 

Following the 2008 financial crisis, stock splits have decreased dramatically. This was due to a long period of slow economic growth during the recession then an increase in fractional share purchases and ETFs.

Prior to ETFs and fractional share purchases, stock splits were a much bigger deal. Today, with so much investing done by institutions and through ETFs, the actual share price is less relevant. Institutions worry about the size of their investment and not the number of shares.

At the end of the day, a stock split doesn’t change any of the fundamentals that increase a company's valuation. It doesn’t increase their profits, add a new product, or improve their research. The temporary increases in stock price and market capitalization caused by splits are great case studies on investing psychology since demand in the stock changes without any business fundamental changes. Increase the number of shares, increase the buzz. You can read more about the cognitive biases at play here and here. 

There are several disadvantages to stock splits. First of all, they cost a lot of money. The firms that perform a split have to pay for new shares to be issued, new prospectus to be written, stockholder communications, etc. For large firms like NVIDIA, the cost is irrelevant. For small and mid cap firms though, that price can be significant. 

Additionally, a stock split typically increases price volatility as the bump in share prices levels out when people remember nothing about the business actually changed. 

During a recent earnings call, Costco’s CFO said there are no plans to perform a stock split even as the share price bounces around $1,000. His main reason was the widespread availability of fractional share purchases to investors. He said:

I think for us, the way we think about it is the economic arguments that were true in the past are a little bit less clear because retail investors and employees both have the ability now to buy fractional shares. But we do also recognize that there's a benefit of the stock feeling more affordable for our retail investors and employees who are very important constituents for us. So, we'll continue to evaluate over time.

Personally, I love this answer. I am biased because I love Costco and everything it stands for, but I do think this answer shows a focus on things that actually improve the performance of the company over shiny stock splits.

ETFs, just like companies, can perform stock splits. In 2024, Schwab performed several splits on some of it’s most popular ETFs, a lot of which I am heavily invested in: SCHG (4 for 1), SCHD (3 for 1), SCHM (3 for 1), SCHK (2 for 1), and SCHF (2 for 1). Schwab does not offer fractional purchases of ETFs therefore maintaining a lower price per share allows investors to purchase and manage allocations much easier. 

For example, in my Roth IRA, I am invested in SCHF, SCHM, SCHG, SCHA, VOT, VOO, and VBK. The Schwab ETFs all have a price around $20 per share. The Vanguard ETFs are $550-$250 per share. If I only owned the Vanguard ETFs, I could be left over with $249 dollars and nowhere to put it. With the Schwab ETFs, the most cash I will ever have is $20 since their share price is lower. 

Yes, I could always purchase a Schwab mutual fund with as little as $1 and have no cash left over. However, I am irrational. I like having a clean IRA with only those ETFs. I know my weaknesses. 

Modern brokerages with fractional shares, ETFs, and mutual funds have decreased the number of stock splits and their importance. As I sit here writing about how they don’t fundamentally change anything with your investment, I would be lying if I didn’t say I got excited seeing my Schwab ETF share numbers drastically increase after their splits. I love making decisions based purely on numbers, facts, and data, but I am human. 

The excitement of a split will always be fun if you already own shares. Don’t go purchasing a bunch of shares because a stock is going to split unless you promise you were already planning to do it and want to hold the company for a long time.

Debrief on Deck

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