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What is a stock split? Here’s how it impacts your investments

March 10, 2022, 4:11 PM UTC

Would you rather own one share of Amazon stock or 20?

It’s a trick question, sort of. Amazon announced Wednesday after hours that it was issuing a 20-for-1 stock split that (subject to approval at the May 25 annual meeting) will go into effect June 6. While stock splits have become less common in recent years, they raise a lot of questions for shareholders. Here’s what you need to know.

What is a stock split?

Think of a share of stock as one pie. A stock split is when a company “cuts” the pie into pieces (or in this case shares), but the total amount of pie remains the same. Typical stock splits are 3-for-1 or 2-for-1, often expressed as 3:1 or 2:1. Generally stock splits are a way to make shares that have risen dramatically more appealing to retail investors. Though they both have the same inherent value, there’s a psychological perception that an investor would prefer to own 10 shares for $100 each, rather than one share for $1,000.

How does a stock split work?

A stock split gives investors more shares for every share they currently own. In a 20-for-1 stock split each investor who owns a single share will receive 19 more. Each Amazon share, which closed at $2,786 on Wednesday, will be 1/20th of the trading price once the stock split goes into effect.

Does a stock split make shares cheaper?

As Fortune’s Anne Sraders previously explained, a stock split does not necessarily make a share “cheaper.”

Sraders wrote: “‘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 [told] Fortune [in 2020 when Apple and Tesla did their stock splits].

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 [explained]. 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,’ [noted] 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 [noted].”

Why is Amazon doing a stock split now?

Searching “AMZN split” on Twitter will certainly give you a wide range of opinions on the matter. Some on Twitter were speculating that given the precipitous tech stock selloff, a stock split will allow more retail investors to rush in now and buy shares or “hold the bag” to support the stock price.

But there’s some evidence that splits have can give shareholders more than a psychological boost. Ruhell Amin, an analyst at William O’Neil, wrote in a Thursday note that, “While the announcement doesn’t change the company’s fundamentals, it should signal a vote of confidence in the company and improve liquidity. Stock splits this large are uncommon—it’s one of the biggest in history.” The note referenced research that stock splits do lead to improved stock performance: “A study by the Nasdaq in 2019 which looked at large-cap stock splits between 2012–20 suggested that just announcing a stock split gave an average boost of 2.5ppts to a stock, and that boost added to average stock outperformance of almost 6ppts after one year. This is broadly consistent with studies that looked at large cap splits from the last 20 years. Since announcing its 20-1 split on 2/1/2022, GOOG has outperformed NDX by 6.2ppts,” the note read. Another note from Bank of America echoed that finding: “Historically, stock splits are bullish for companies that enact them, gaining 25% one year later vs. 9% for the broad market,” the analysts wrote.

Are Google and Tesla planning stock splits?

Google is—the company announced it is doing a 20-for-1 split that will go into effect July 15. That leaves Tesla, which opened at $851 Thursday, the highest flier. Another example, of course, is Warren Buffett’s Berkshire Hathaway. Though the Oracle of Omaha has of late embraced tech stocks and even dipped his toe into crypto, stock splits do not appear to interest him: Berkshire stock closed at $488,245 a share on Wednesday.

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