Warren Buffett (Trades, Portfolio) does not endorse stock splits for the simple reason of these financial transactions not adding any fundamental value to a company or its business operations.
Regardless of this reality, investors tend to reward companies that decide to split their stock, as it makes investing in the company more widely accessible.
During its fiscal third-quarter earnings conference call on July 30, Apple Inc. (AAPL, Financial) announced a four-for-one stock split, immediately sending the shares to new all-time highs. Since the revelation, the stock has soared approximately 18% through Aug. 12 to settle at $452 a share.
At the end of the first quarter, Apple accounted for more than 35% of the Berkshire Hathaway Inc. (BRK.A, Financial) stock portfolio.
Source: GuruFocus
This large position might prompt Buffett to take a harder look at why Apple would want to go down this path.
The guru's view on stock splits
Berkshire Hathaway Class A shares were never split despite constantly trading at a staggering price of above $250,000 per share. This decision by Buffett is a clear indication of his belief that a company should not be wasting energy or time to execute transactions that add little value to shareholders in the long run. During the annual shareholder meeting in 1994, the guru opened up about the subject and said:
"I think most people think that the stock would sell for more money post-split. We wouldn't necessarily think that was advisable in the first place. In the second place, we don't think it would necessarily be true over a period of time. We think our stock is more likely to be rationally priced over time following the present policies than if we were to split in some major way. And we don't think the average price would necessarily be higher. We think that the volatility would probably be somewhat greater, and we see no way that volatility helps our shareholders as a group."
Buffett, however, is not entirely against allowing retail investors to invest in a highly profitable company by introducing a cheaper option. He created Berkshire class B shares for this purpose. In fact, class B stock was split 50 to 1 in 2010 to make it more accessible to investors of every size and scale. This is an indication that Buffett is willing to be flexible with his stance on stock splits if the benefits to investors are clear.
Apple's decision is likely driven by two reasons
First, the company seems to want to give an opportunity for more retail investors to be part of its growth story. Chief Financial Officer Luca Maestri made this clear during the earnings call.
"Today we are announcing a four for one stock split of Apple common stock to make our stock more accessible to a broader base of investors. Each shareholder of record at the close of business on August 24, 2020 will receive three additional shares for every outstanding share held on the record date and trading will begin on a split-adjusted basis on August 31."
Even though the company would not admit it publicly, the desire to remain as a member of the Dow Jones Industrial Average might have played a role in Apple's decision as well. Unlike the S&P 500 index, which is market capitalization-weighted, the Dow is price-weighted, meaning companies with a higher stock price have more impact on the directional movement of the index on any given day. A high degree of influence on the value of the index is often considered as a warning sign due to the regulatory attention it could draw toward the company. At the current price of $452 per share, Apple has a weighting of over 11% in the index.
Source: IndexArb
The proposed split will bring it down below 3%, which would be a win for both the company and the index. From my obervations, I think Apple respects the inclusion in the Dow to an extent that it factored into the decision to split the stock. For instance, Apple's stock price was considered too high to be included in the Dow before 2015, and the company then decided to execute a seven for one split to reduce the price per share substantially. This prompted the Dow oversight panel to include Apple in the prestigious index for the first time. Five years down the line, the company seems to be following the same principles to remain as part of this index.
Beware of a temporary collapse of the stock price
The recent gains post the announcement of the split might soon evaporate due to the expected outflows from passive funds that track the Dow. As Apple's weighting will drop substantially starting from Aug. 31, index funds would be forced to liquidate a sizeable portion of Apple shares to accurately mirror the Dow. As the below table confirms, the top 10 shareholder list of Apple is dominated by institutional investors, and most of these funds hold Apple in passive portfolios.
Source: GuruFocus
The expected selling pressure will likely lead to a collapse in the stock price in the first couple of weeks following the stock split, but could recover soon, especially since the new iPhone devices are expected to be announced in mid-September.
Conclusion
The tech company has got many things going for it. First, Tim Cook's vision for Apple as a services company is coming to fruition as the company continues to tap into the lucrative content streaming industry and the health care sector.
Source: Statista
There's still a long way to go, but the company is certainly on the correct track as smartphone sales are expected to decline on a global scale as the industry matures. If Apple had not been proactive in opening new doors, the company would have been at risk of lagging the market.
Second, the company has a renewed focus on developing low-cost iPhones to gain traction in emerging markets such as India, which is the right strategy as the industry has already saturated in developed markets.
Third, the rollout of 5G technology is expected to trigger a super cycle in device upgrades, which is good news for Apple. In January, AT&T (T) Chief Operating Officer John Stankey said:
"We are coming off a record-low upgrade rate for any fourth quarter in our history. But fast forward to the back half of this year when popular 5G smartphones and devices should be more available at scale, you can expect higher upgrade rates."
Apple is planning to unveil its first 5G iPhone this September, and a better-than-expected fourth quarter is on the cards if consumers embrace this product, which has usually been the case in every instance the company introduced a revolutionary device.
Taking these recent developments and the brand value of Apple into consideration, I think the company is likely to remain part of Berkshire's investment portfolio for quite some time.
Disclosure: I do not own any stocks mentioned in this article.
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