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Here’s what a stock split means for investors

Plate with coloured wedges being parcelled out like a slice of pie representing a share split
Image source: Getty Images

A stock split is a term that has recently been all over the investing world. Why? Well, because one of the largest companies in the world — Apple Inc. (NASDAQ: AAPL) — has recently announced a fresh stock split. So although companies on the ASX aren’t as prolific with stock splits as our friends over in the United States, understanding how these splits work is still a valuable piece of investor information that I think everyone should have their head around.

What is a stock split?

A stock split is… well, it’s all in the name. It refers to the process of a company deciding to ‘divide’ existing shares into smaller parts. Apple announced last week that it would be undergoing a 4-for-1 stock split soon. This means that an existing Apple share will be split into 4 parts, each worth a quarter of what the ‘unsplit’ shares are valued at.

To be very clear, this has no impact on the value of a person’s Apple holdings. Say I have 2 Apple shares worth US$445 each before the split takes place. After the split, I will have 8 Apple shares worth approximately US$111.25 each. My overall Apple position has not changed one iota. It’s really just a game of arithmetic at the end of the day.

Why do companies do it?

Because a stock split has no real impact on any current or future investors, it can be hard to understand why a company would want to split their shares. The usual explanation is that it ‘levels the playing field’ of potential new investors to the company.

If a company has a $5 share price, virtually anyone who can buy shares in the first place is able to invest in said company. But take a company like Amazon.com Inc. (NASDAQ: AMZN). Its shares are presently valued at more than US$3,000 (A$4,193) each. Many newer retail investors simply don’t have that kind of capital to sink into one company. One famous example is Warren Buffett’s Berkshire Hathaway Inc. (NYSE: BRK.A)(NYSE: BRK.B). It has never, in its long history, split its A-class shares. As a result, one single BRK.A share will set you back around US$315,000 today.

The logic goes that those potential investors that might not have wanted to buy Apple for US$450 might be more inclined to do so if Apple shares were closer to US$110. And more buying pressure of any kind is good news for existing Apple shareholders.

But in reality, I think stock splits make for good public relations and not much else. Something to remember when you next hear the term ‘stock split’!

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Amazon, Apple, and Berkshire Hathaway (B shares) and recommends the following options: long January 2021 $200 calls on Berkshire Hathaway (B shares), short January 2021 $200 puts on Berkshire Hathaway (B shares), short January 2022 $1940 calls on Amazon, long January 2022 $1920 calls on Amazon, and short September 2020 $200 calls on Berkshire Hathaway (B shares). The Motley Fool Australia has recommended Amazon, Apple, and Berkshire Hathaway (B shares). We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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