Do Stock Splits Create Value?

Tyler Durden's Photo
by Tyler Durden
Monday, Apr 04, 2022 - 12:30 PM

Something remarkable has been happening in markets in recent weeks: an event which every capital markets theory, even the most crackpot ones, says shouldn't affect stock prices is instead having a major upward impact on stock prices. We are of course taking about the recent flood of stock splits announcements which has lifted the shares of such tech giants as Amazon, Google, Tesla and, most recently, Gamestop. 

This in turn has prompted question: even though it clearly does not in theory, do stock splits somehow create value?

As Petr Pinkhasov of Pivot Analytic writes over the weekend, Amazon, Google and Tesla rose nicely on stock split announcements. He expands below:

Finance theory says that no matter how you slice a pizza, you can’t create more food. Changing the share-count does not alter the value of the company. The value of the company is independent of the number of shares. Theory and practice differ greatly. Business and Economic theory assume that people are constantly optimizing economic outcomes. Reality is different. When was the last time you woke up in the morning and thought “I am so excited about my job today, I work for a boss who is a rational, optimizing economic person!”. Of course not. You wake up thinking “my boss is an idiot”. Markets are a collection of these idiots, which make them very efficient and difficult to outsmart. Its tough to outsmart someone who is unpredictable, self-destructive and makes decisions on bad information.

Even though its tough to outsmart the market, you can still ensure that you do well. If you consistently make bad decisions combined with shoddy research, you WILL underperform and you will destroy value. Making good decisions based on solid research does not guarantee results but it maximizes the chances that you will do better than average and it really maximizes the chance that you don’t do poorly (i.e. a bit below average is not that bad but you don’t want to do poorly).

The recent action in AMZN, GOOG, TSLA and now GME demonstrate both the unpredictability and irrationality of the markets. Even more interesting is that people are painting GME and AMC with the same brush. No way that GME’s stock split should add 5% to AMC’s pre-market price, but it did.

A lot of crazy things are happening: Covid closed down the world, oil prices went negative then rose over $100, and now Putin invaded Ukraine and got “cancelled”. One way to stay safe is to focus your investing on utility and focusing on what you need. You need food, shelter and power. A portfolio of food companies, REITs & Homebuilders, and utilities should perform admirably in almost any market environment. Stocks like GME and AMC are speculative at best. A DCF on AMC shows a valuation range between $0 and $15 per share, assuming it is a movie cinema company. AMC deftly is trying to become a conglomerate, but in reality that is not going to be that important for a long time. GME is more interesting, as it has a plan to get into NFTs and other exciting areas to offset its declining core business. Still, neither movies, video-games or NFTs are necessary items. These are products you want, not products you need. In a bull market, products you want usually do fantastic. But, in times of risk like today, re-positioning your portfolio away from wants and towards needs is helpful. Stocks of utilities are likely to make money whether interest rates go up or down, and they should make money in most geopolitical environments. In a massive bear market, they will lose the least. You can’t sit on cash in 7% inflation, so look for conservative stocks that are still growing.

Then there was CNN's hot take, which despite the badly mangled title claiming GME stock is somehow becoming more "affordable", is actually not as idiotic as it sounds..

... because what the imploding left-wing propaganda outlet is trying to convey is that by splitting its stock, the company becomes more accessible to a broader universe of traders. Whether that is a good or bad thing, remains to be seen especially once the next selloff kicks in and more retail traders puke.

Another, much more erudite stock split take comes from DataTrek's Nick Colas who last week was on CNBC talking about Tesla’s possible stock split, and writes "I don’t know if it is just me, but whenever I do media appearances the ratio of preparation time to actual airtime is usually about 10:1. The interviews you see on business TV are never scripted; you simply do not know in which direction a conversation might go. Therefore, one must prepare for any eventuality. I usually write up small index cards of notes and put them on my laptop so I can glance down at them during the interview. I think I had 5 of them today…" Without the limitations of a CNBC interview, he goes on:

The reason stock splits are such a tricky topic to discuss is simply because they shouldn’t mean anything at all. That’s first day of Finance class in undergrad or grad school stuff: a company has the same value regardless of how many shares are outstanding. And yet, in the last few months we’ve seen Google, Amazon and now Tesla (most likely) announce they are “doing the splits”.

Since I spent the first decade of my Wall Street career as a de facto investment banker (that’s what analysts really did in the 1990s), I think about corporation finance concepts like “Company ABC should split its stock” in pitch book terms. What arguments would I use to convince a C-level executive or a board that this idea had merit?

The most important page of a pitch book is the cover; it simply must have a punchy tagline. I still remember one from the mid 1990s, when my employer (the old First Boston) pitched Chrysler on a huge equity deal to clean up its balance sheet. It was: “The Sun, The Moon, The Stars. Everything Is Aligned.” And so it was. The company was doing well, the US economy was strong, and investors were buying cyclical stocks again. The Sun, the Moon, the Stars … All in alignment, but that doesn’t last forever. “Act now!” was the implicit message to management and the board.

The cover of my pitch book for a Tesla stock split would say: “Memes, Dreams and Themes”:

  • Memes. Elon Musk is famous for the attention he gets on social media, and a lower priced stock would be attractive to retail investors who want to be part of his story. Yes, they can probably buy 0.1 shares on some online brokerage, but they’d likely be more interested if they could buy 1 share after a 1:10 split. And maybe, they’d spring for 2 or 3 shares.
  • Dreams. To recruit the best tech talent and fulfill its long-term promise (the “Dream”), Tesla has to offer equity to employees. So do Google and Amazon, and in some cases all three companies are competing for the same talent. Both GOOG and AMZN just announced stock splits, so TSLA needs to do it as well. Yes, it’s all optics, but you don’t want to lose a promising Stanford EE to Google because they gave him more shares.
  • Themes. Democratization of investment opportunity. A bigger tent for the Musk brand ahead of a SpaceX IPO. Saving the world. Big themes don’t need big stock prices. Smaller can be much, much better since more people can climb on board.

Takeaway: all this may sound frivolous, but I can assure you that without a great pitchbook not much gets through a large company, through to its board, and executed. Will a split make any difference to Tesla’s stock price over time? I doubt it, but here’s the thing: it might help, and it costs the company essentially nothing aside from some incremental listing fees at the NASDAQ. And make no mistake: now that 3 of America’s pre-eminent Tech companies are splitting their stock, there will be more to come both inside and outside the Tech world. There are almost certainly investment banking associates writing up the first draft of a pitchbook right now …

Whatever the answer, and judging by the recent rallies in mega cap stocks splitting for now it appears that value is in fact created in practice if not in theory, banks are already rushing to capitalize and last month Bank of America published a report following Google's stock split, in which it correctly saw the possibility that other tech firms could take note and do likewise, and noted that "if more corporate managers adopt shareholder-friendly postures, it could spark a wave of splits and bring more investors flows into the market, proving support for embattled growth companies."  The bank also published its list of most likely future stock split candidates, those S&P 500 stocks trading above $500 -  a group which represents $5.7 trillion in market cap, or about 15.5% of the index. One of the companies listed, Tesla, indeed went ahead with a stock split announcement just a few weeks later...