More About Stock Splits, and Some About Reverse Stock Splits


Chief Strategist at Interactive Brokers

Yesterday, in light of the upcoming 4:1 split in Apple (AAPL), we noted how stock splits should be considered largely irrelevant to the investment thesis behind a company.  Think of it as making change.  If you have a $20 bill and I exchange it for four $5 bills, are you in any different financial shape?  In the days before odd-lots were commonplace and before fractional shares were widely available, one could make the case that a stock split made a company more accessible to small investors.  In the current market environment, does anyone have a valid concern that small investors are failing to participate in the highest flying shares?

Stock splits were quite popular in the high-flying days of the late ‘90s.  The announcement, or even the rumor of a stock split was enough to send shares soaring.  That said, we were in the midst of a market mania and many investors learned the hard way that splits, in and of themselves, mean virtually nothing to the fundamentals of a company.  In that era, however, odd-lots were still frowned upon and fractional shares were not remotely considered.  One could argue that a stock split did indeed improve a stock’s investment prospects.

There is always the thought that a stock split ratifies a company’s success.  That’s true, to the extent that only companies with soaring stock prices consider splitting their shares.  Honestly though, does anyone need a stock split to ratify the investment performance of AAPL?  Isn’t a 130% one year price rise already sufficient to prove that point?

Until now we have discussed the basic form of stock split, when a company gives a holder a multiple of the shares they already possess in order to reduce a high stock price.  The flip side of that transaction is a reverse stock split, when a company reduces its share count in order to raise its stock price.  That type of transaction has been much more common recently, and is indeed a signal about a company’s prospects.

Unfortunately, a reverse stock split is usually a desperation move.  Various exchanges, indices and investment mandates require a stock to trade above a certain price to maintain a listing standard.  If a company is unable to improve its investment prospects sufficiently to allow the market to value it at a higher price, it resorts to a reverse split to achieve that. Healthy companies rarely, if ever, encounter this problem, so markets rightly understand that a reverse split is a company’s admission of weakness.  Of course, by the point that a company needs to even consider a reverse split to meet listing standards, the market has already given its verdict.  Recognizing this, markets are rarely fooled by the reverse stock split gambit.

Thus we have two types of stock splits, one benign but considered a positive; one malignant but usually recognized as such.  Hopefully our discussion of the topic will offer some clarity amidst market hype.

Read Steve’s Referenced Post Here:

Apple, the Dow, and a Stock Split – Only One of These Should be Relevant

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