What stock splits tell you about a company

A handful of big technology companies have split their shares this year after pandemic-induced bull runs of the last two years.

The question for investors is how to view them. Are they a signal it’s time to jump in or a development that’s interesting but should be ignored?

Tesla Inc. (NDQ: TSLA) has become the latest to join in with shareholders approving a plan for a 3-for-1 split which went into effect Aug. 25. It is Tesla’s second split in two years.

Tesla’s move follows Alphabet (NDQ:GOOG), the parent company of Google, which split both classes of its shares by a 20-for-1 ratio in July. In June, Amazon (NDQ: AMZN) did a 20-for-1 split and Shopify (NDQ: SHOP) split 10-for-1, also in June.

“Splits makes shares more affordable and accessible, but in the grand scheme of things they don’t change anything,” says Hans Albrecht, vice-president, portfolio manager and options strategist at Horizons ETFs Ltd. in Toronto. “But it does leave a positive perception that things have gone well for the company.”

Mr. Albrecht says since the splits tend to occur after a long run up in prices they signal momentum and suggest that better things lie ahead.  

Splits don’t give shareholders any more value because such things as earnings and sales per share, as well as dividends are also split in the same proportion. The splits do make the shares more accessible to small investors and increase the liquidity of the company’s stock. That makes it easier to buy and sell the shares and narrows bid-ask spreads.

Bank of America research analysts have concluded stock splits are traditionally bullish for the companies that enact them. They looked at data on S&P 500 stocks going back to 1980 and found that companies that split outperformed the index in the three, six and 12 months after the initial announcement. They gained on average 25 per cent over the next 12 months compared with a gain of 9 per cent for the benchmark index.

 Evolve Funds Group Inc. launched its FANGMA Index ETF (TSX:TECH) in May 2021 at a time when it cost more than $7,000 to buy one share of each of the six companies in the index. The ETF follows Facebook (Meta Platforms) Amazon, Netflix, Google (Alphabet), Microsoft and Apple.) So to buy a board lot of 100 shares of each was over $700,000.

Amazon’s shares are 24 per cent below their 52-week high post-split at the current price of US$143.55. Alphabet is down 20 per cent at current prices.

As the Globe and Mail’s David Berman noted in a recent primer, splits fell out of fashion 20 years ago. From an average of 58 stock splits per year in the 1990s among companies in the S&P 500, the numbers  fell to 8 splits per year in the 2010s.

Elliot Johnson, chief investment officer at Toronto-based Evolve Funds Group Inc. says the    broader participation created by the splits has benefits.

That trend hasn’t helped the companies that split this year. Their shares prices are down year-to-date and well off the prices when the splits were announced. Split adjusted, Shopify has fallen 77 per cent from it 52-week high at the recent price of $52. As business conditions have deteriorated, Shopify is laying off 10 per cent of its workforce and warning  that inflation and rising interest rates will weigh on consumer spending for the remainder of 2022.

“That’s not user friendly for the investing public and keeps advisors from allocating equities with large share prices to smaller accounts,” Mr. Johnson says.  Another advantage of lower share prices is that they allow for easier option trading. One call option represents 100 shares, so as an example, before Amazon’s  20-to-1 split, it was trading at US$2,800 per share.  Institutions and portfolio managers wanting to use a covered call strategy needed a minimum size of $280,000.

“This makes higher priced shares unsuitable for all sorts of applications, even institutional strategies. There’s no upside for the company to make their shares less accessible, so share splits are more helpful than not.”

Ultimately, splits may be one more reason to buy a company, but not the main one, says Mr. Albrecht. More important is how its business is performing and the prospects.

“It should never be the primary reason,” he says.

This article appeared in the Globe Advisor section of the Globe & Mail’s Report on Business on Aug 24, 2022. For reprint information please view this page.