Stock splits: Everything investors need to know in light of Apple’s and Tesla’s moves

Here’s everything investors should know.

What is a stock split?

A stock split occurs when a company increases the total number of outstanding shares for the price of the same share, effectively breaking one share into several smaller whole shares. For example, a company could do a 4-for-1 stock split, where one $400 share would then become four $100 shares, and existing investors would get three extra shares for each one they own.

In general, stock splits are done when a company’s share price has gotten high, and the stock is then split to lower the price of each individual share and make the shares more accessible and appealing to individual or retail investors who might not have been able to afford the stock before.

Does a stock split make shares cheaper?

This is perhaps the main misconception of stock splits—a stock split does not necessarily make a share “cheaper.”

“The cost per share is less, but the valuation has not changed, so it’s not cheap—meaning it doesn’t automatically become undervalued, it has the same value metrics that it did before,” CFRA’s Sam Stovall tells Fortune.

Indeed, while the stock will become less expensive to buy, none of the valuation metrics or price-to-earnings ratios have changed, and the market cap of the company stays exactly the same. The dividend yield overall won’t change, but the dividend per share may be reduced by the same divisor as the split.

“You’re getting exactly the same, but you have to buy more shares at a lower price in order to equal the amount that, let’s say, your friend has,” Stovall explains. For example, if your friend owned two shares of Apple for $1,000 before the split, they’d now own eight shares. For you to equal those original two shares your friend had, you would have to buy eight shares of Apple instead of two.

But since the price is lower for the shares (and perhaps now in budget), a stock split “drives optimism around more retail investors, [but] most institutional investors couldn’t care less, because it doesn’t change the math,” notes Edward Jones analyst Logan Purk, who covers Apple.

The upshot is that “it’s more psychological. People prefer to buy and sell an even number of shares, and they like to pay within a particular range if possible,” Stovall notes.

Why do companies do stock splits?

Thirty years ago, it was fairly simple why companies did stock splits. But in 2020, some experts are scratching their heads.

“It used to be that you wanted a lower price, because it was beneficial to buy a round lot, a round lot being 100 shares,” says CFRA’s Stovall. It was previously more expensive to execute trades under 100 shares, Howard Silverblatt, senior index analyst of product management at S&P Dow Jones Indices, notes, and Stovall says investors used to want to pay around $40 to $80 for a stock. When companies’ stocks started popping up higher, they’d consider a stock split to make the shares more accessible.

In fact, in 1997, there were 102 stock splits among companies in the S&P 500. But so far this year, there have only been three (including Apple), per S&P Global data.

It’s clear stock splits have fallen out of favor in recent years, especially with the advent of fractional shares—a practice that has become increasingly common and popular on trading apps like Robinhood. Fractional investing allows investors to buy a fraction of one share for less than the cost of a whole share. Or, in other words, you can buy $100 of Tesla, even though the price of one share is much higher.

In that sense, “You might then say, well, because of fractional shares, aren’t these stocks attractive to consumers anyway? I don’t really have an answer to that,” Stovall says.

Indeed, the general idea of stock splits is somewhat similar: companies want to make their shares more accessible to a broader base of investors. And, at least previously, stock splits were viewed “as a strong vote of confidence from the company that their stock was stable and going up,” Silverblatt suggests.

Since the pair announced their splits, Tesla’s and Apple’s stocks have jumped more than 60% and 30% respectively, as of Friday’s close. Silverblatt, for one, notes there will likely be a lot of trading volume for the stocks on Monday, and suggests other companies will be eyeing their performance over the next few days.

Do you lose money if a stock splits?

No. A stock split won’t change the value of your stake in the company, it simply alters the number of shares you own. If you owned two shares of Apple at $1,000 before its 4-for-1 stock split, you’ll still own $1,000 of Apple, but you’ll own eight shares instead of two (you’ll get three extra shares for each one).

“Basically, optics is a really good way of describing it: It just makes the stocks look a little different, even though they’re not,” Stovall says.

And current investors need to remember: “They didn’t lose or gain anything, it’s just that these shares have become closer in reach to those investors who have a ceiling as to what price they will pay for a stock,” notes Stovall.

Should you buy Apple and Tesla after their stock splits?

For investors thinking about buying in post-split, Stovall has some advice: “Pretend the stock split didn’t occur, would you buy Tesla today? If you say, ‘Oh, I’ll only buy it at the split price, I won’t buy it at the prior price,’ the metrics are exactly the same…So why is one attractive and the other not?”

Indeed, Silverblatt says the long term investor needs to “look at the stock and determine if this is a value you want to go into, not the hype of the moment.”

But that doesn’t mean some analysts aren’t positive about Tesla’s and Apple’s stock splits and what it might mean for stocks from other big tech companies, which are likely watching the results closely. “Ultimately we expect more tech giants to potentially head down this path over the coming months as the parabolic rally in tech/EV names over the past five months has put companies in a position of strength to make such moves,” Wedbush’s Dan Ives wrote in an Aug. 12 note. And for Tesla in particular, Ives says, “given its strong retail base and growing appetite among investors around the…overall EV demand, we believe this is a smart strategic move at the right time for the board to make.”

So, is this the start of a slew of new stock splits?

“Logically, [the idea of doing a stock split now] is not there. However, the people who brought you something called an iPhone or an electric car—ignoring them is not a wise move,” Silverblatt argues. “If companies are looking at it, investors have to look at it. Doesn’t mean you have to buy into it.”

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