Apple’s plan to split its stock in two weeks has generated a lot of news coverage, a flurry of discussion and a modest boost for the company’s stock price. Apple’s shares closed at $90.13, up from last week’s closing price of $81.21.
But what exactly does it mean when a company splits its stock? And what’s the benefit? The answer to that latter depends on whether you’re asking from the perspective of the company, its investors, or the people who might consider snapping up some of those newly priced shares.
First, the facts about Apple’s upcoming split: On February 28, each Apple shareholder invested in the company as of the close of business Friday will receive an additional share of Apple stock for each one they already own. The move will boost Apple’s authorized shares to 1.8 billion from 900 million. When the split takes effect, the price of Apple shares will be halved. (If Apple’s per-share price were to close at $88, for example, it would be adjusted to $44 post-split.)
What It Means
Splitting a stock and increasing its available shares boosts liquidity, or the ability to sell an asset and convert it to cash without a substantial change in price. “The more shares that are freely traded, the easier it is for big investors to get in and out of a stock,” says Gene Munster, a senior research analyst at Piper Jaffray.
But there’s a flipside, Munster adds. Halving the per-share price of a stock creates the perception that it’s cheaper—“The reality is that it’s not,” Munster says—which could attract a new pool of investors.
“From a perception standpoint, the average investor flinches at $88 [per share],” Munster says. “[To them], $44 sounds less expensive.”
Tim Beyers, a Motley Fool contributor, is more blunt. A stock split “doesn't do anything to make it more affordable,” he says. “It’s an illusion.”
Or to put it another way: say you purchase a stock at its post-split price. “Your claim on earnings is exactly half of existing shareholders’. You bought a share of the stock, but you get half the take,” says Beyers, who described the Apple stock split as “a meaningless move” in his Motley Fool column. “There’s no implicit discount.”
Analysts may agree on a split’s effect on prices. But what’s less clear is how a split can affect the volatility of a stock. One school of thought holds that by attracting smaller investors who may be more likely to jump in and out of investments, a post-split stock is subject to more volatile price swings. Other analysts, including Piper Jaffray’s Munster believes the greater liquidity brought about by a split means great stability.
Apple’s own history with stock splits has been turbulent. In the months after the company’s two prior stock splits in 1987 and 2000, per-share prices dropped significantly. However, both instances look to be victims of bad timing as opposed to any risk inherent to stock splits; Apple’s 1987 split occurred just a few months before the October 1987 stock market crash, while the 2000 split came right before a slump hit the entire tech industry.
Reason to Buy?
Still, there’s one other potential positive aspect to a stock split, analysts say: companies usually make such a move when they expect to hit earnings forecasts and avoid other nasty surprises that could trigger a sell-off. “It sends a positive psychological message that there’s nothing bad on the horizon,” Munster says.
Nevertheless, analysts caution against relying on a stock split as the deciding factor in whether or not to buy stock in a company. Beyers contends individual investors should consider a company’s earnings and cash flow and whether or not it has a sustainable business when considering stock purchases. “A stock split really isn’t [a good reason to invest],” he adds.
Instead, Beyers says, investors should ask themselves whether they would buy the entire company for its market capitalization—the stock price multiplied by the number of outstanding shares—if they the cash to do so.
“That's the question that institutional investors ask, and those guys beat the market on a routine basis,” Beyers adds.
This story, "Apple stock split: What does it mean?" was originally published by PCWorld.