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Are Stock Splits Good for Investors?

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Stock splits are common and usually celebrated by investors.

E-commerce giant Amazon (NASDAQ:AMZN) has become the latest major company to execute a split, dividing its stock on a 20-for-1 basis and lowering the price per share from more than $2,000 to under $125 in the process. In July, Google parent company Alphabet (NASDAQ:GOOGL) will also initiate a 20-for-1 stock split.

Other significant companies that have announced splits of their stock this year range from high-end furniture retailer Restoration Hardware (NYSE:RH) to Canadian e-commerce company Shopify (NYSE:SHOP).

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But while stock splits are popular and occur frequently, a debate continues to rage about whether they are necessary or have any meaningful long-term impact. As AMZN stock begins trading on a split adjusted basis, we look at whether stock splits are good for investors.

Why Split?

Companies usually split their stock when the share price has risen to a point where they become too expensive for individual investors to afford.

Amazon stock, for example, last split in 1999, and over the past 23 years it rose more than 4,300% to trade at a 52-week high last summer of $3,773.08 a share. Paying more than $3,500 for one share of a company’s stock can be prohibitively expensive for many individual investors.

Certainly, AMZN stock is much more affordable and attractive at under $125. By splitting the stock, companies lower the price and make them more affordable to a greater number of investors. This expands the shareholder base through increased buying, which can lead to a rally in the share price.

Of course, there can be other reasons for companies to split their stock. These include to boost liquidity, to help a company more affordably buyback its owns shares, and, in rare cases, for legal or regulatory compliance reasons.

But generally, stock splits are carried out when a company feels its share price has gone beyond the reach of average investors. In addition to boosting interest in a stock and enticing investors to buy shares, a split can also lead to a company’s stock being added to a new index.

For example, there is speculation that Alphabet’s stock might be added to the Dow Jones Industrial Average after it splits on July 15 of this year. Were that to occur, GOOGL stock would then need to be added to mutual funds and exchange traded funds (ETF) that track the Dow, leading to even more buying of the stock.

The Case Against Splits

Many analysts and professional investors criticize stock splits, saying they are a cosmetic procedure that does not change the underlying fundamentals of a publicly traded company or increase the valuation of a stock. This is because there is no change to a company’s market capitalization following a split since the price of each share splits along with the number of shares outstanding.

The pie is still the same size, it’s just been cut into more pieces, say critics.

Additionally, nothing changes with a company’s management or earnings following a stock split. Amazon is the same company today as it was before the 20-for-1 stock split occurred.

Meanwhile, stock splits can be expensive for organizations to execute, and can be a hassle in terms of the legal and regulatory oversight that is involved. Critics grumble that companies spend a great deal of time and money to split their stock while adding no shareholder value.

For these reasons, some companies have refused to ever split their stock. The most famous example being Berkshire Hathaway (NYSE:BRK.A), the holding company of legendary investor Warren Buffett.

In 1964, Buffett gained a controlling interest in Berkshire Hathaway, at which time its share price was $11.50. Since then, Buffett has increased the share price greatly while refusing to split the stock. The result is that today, Berkshire Hathaway’s class A shares recently traded at $469,560 each, putting them far out of reach for most investors.

Berkshire’s class A shares are the most expensive security in the world and the huge price per share has caused headaches for the New York Stock Exchange over the years.

While he has acknowledged that the price of Berkshire Hathaway’s class A shares is “awkward,” Buffett’s has said repeatedly that he’ll never split the stock. His reasons include that the high price attracts only serious investors who will hold the shares long-term. If he were to split the stock, Buffett has said, it would likely attract more speculative investors and lead to more active trading of the shares.

“We want to attract shareholders who are as investment-oriented as we can possibly obtain, with as long-term horizons,” Buffett has said.

The Oracle of Omaha, as Buffett is known, also likes to joke with his friends, saying “May you live until the A stock splits.”

That said, in 1996, responding to criticism from the investment community, Buffett created a cheaper class of B shares (NYSE:BRK.B) that trade for far less than the price of the class A stock, making them much more affordable at their recent price of about $312.

Today, there are just over 600,000 class A shares of Berkshire Hathaway outstanding, compared to more than a billion class B shares.

Final Analysis

How people feel about stock splits largely depends on the type of investor they are. Individual retail investors tend to welcome stock splits as it provides them with access to shares in a company that might have been previously too expensive for them to buy.

An investor who had $2,000 to spend wouldn’t have been able to buy one single share of AMZN stock before it split on June 6. But now, that same investor can buy more than 15 shares of Amazon stock with $2,000.

Deep pocketed institutional investors and professional money managers who have access to millions or billions of dollars tend to dismiss stock splits as insignificant. But for them, spending $2,000 or $3,000 on a single share of a company’s stock is not overly expensive.

Judging by the number of companies that continue to line-up to split their stock, publicly traded concerns continue to see value in the practice of making their shares as affordable as possible to the broadest number of investors. The fact that a stock split can help individuals take a position in a company’s stock makes them of value.

That stock splits don’t change the fundamentals of a company or increase the valuation of a stock is not really the point of a split.

Disclosure: On the date of publication, Joel Baglole held long positions in GOOGL and BRK.B. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines

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