06.29.2022 | Insights

What is a stock split?

By Lowell Hansen
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What is a stock split, and should I buy?

I had several clients call after Amazon announced a 20 for 1 stock split several weeks ago.  It got me thinking “do investors understand what a stock split means?”.

So, what is a stock split?  Each shareholder on the day of a stock split will receive additional shares for each share that they own.  For instance, on a 5 for 1 stock split, the investor will receive 4 additional shares for each share that they own.  Sounds good?  You do have more shares; however, the stock price is also adjusted accordingly.  In the 5-1 example, if a stock was trading at $500 per share, pre-split, the stock price is adjusted down to $100 per share.  Your portfolio value pre-split was $500 and post-split is still $500.  Dividends are similar.  If a company was paying $1.00 per share pre 5 for 1 split will be adjusted down to 20 cents.

Why companies split shares?  The impact on the company is nothing.  However, there can be a short-term pop in the stock price.  This is more of a behavioral finance issue than economic.  Shares are cheaper so therefore felt like a bargain.  Historically, stocks in the S&P 500 have risen 5% in the year following a stock split.

In the case of Amazon, the pre-split price was $2,447 and post-split was $124.79.  That feels like a bargain, right?  However, it is still at over 52x earnings, which is 2 times what the S&P500 is currently trading at.

It should be noted that at the time of writing this piece, Amazon is trading at $107.55

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