Note: Fisher Investments doesn’t make individual security buy-or-sell recommendations. Any security mentioned herein is merely incidental to the broader point we are illustrating.
Several of America’s largest, most widely held and highest-priced stocks have recently dotted headlines by announcing stock splits—including investor darling Tesla’s (TSLA, Financial) second in two years. Such announcements garner significant attention—and they are often received positively by investors. But in Fisher Investments’ view, stock splits are a whole lot of nothing. They are neither good things for investors nor bad. Paying them much attention is time you could better spend analyzing something else.
Stock splits are zero sum
Stock splits don’t change anything fundamental about a company, and they don’t change investors’ stake in the future profits of a company. For example, imagine you owned 10 shares of a company. We will call it SplitCo because we at Fisher Investments are creative. SplitCo is currently trading at $1,000 per share, which SplitCo management thinks is much too high. That is a total value of $10,000 (10 shares times $1,000). So they announce plans to split the stock 10-for-1. If SplitCo shareholders approve this plan, on the effective date you would own 10 times as many shares—but at one-tenth the share price. The value is still $10,000. Unchanged.
Moreover, nothing fundamental about your ownership has changed. In Fisher Investments’ view, the chief thing you own when you buy a stock is a stake in the future profits of the company—the earnings per share. If SplitCo multiplies its shares outstanding 10-fold as in our prior example, the earnings per share would be divided by 10. But since you own 10 times the shares, your stake isn’t diluted. Again, nothing changed. Consider the inverse: Sometimes extremely low-priced companies with terrible fundamentals from a profit-and-loss standpoint—penny stocks—will enact reverse splits to boost the share price, moving it further from zero. But that changes nothing; the company still likely has terrible fundamentals.
A behavioral error that feeds stock split biases
Very often, Fisher Investments finds that investors’ positive bias towards stock splits stems from the fact that they often follow steeply climbing share prices. In our experience, investors’ attitudes toward stocks they own are heavily influenced by recent price movement. If a stock fell, many investors will label it a “loser” and sell it at the first good opportunity. If it rose, the company is a “winner.” A stock that is splitting after a big rise tantalizes investors with notions that it will repeat the climb—and they will have an even bigger stake. In Fisher Investments’ experience, these folks often focus on share price. If they had 10 shares of SplitCo before the split, and its price rose by $1 per share, their holding would rise by $10. After the split, if the stock price rose by $1 per share, their holding would rise by $100. Problem is, that ignores that the split reduced each share’s portion of the company’s total value. A $1 per share price rise after the split is mathematically the same as a $10 per share rise before it. Thinking in terms of the percentage increase, instead of the dollar-based increase, can help you see through this.
Then too, all this thinking is backward-looking. Stocks’ past returns and price movements have no bearing on future returns. Stocks are inherently forward-looking, incorporating hopes, fears, optimism, pessimism, forecasts and news about the company into pricing near-instantaneously, in Fisher Investments’ view. So to us, owning a stock because it split after a good run is a sign of a potential analytical problem. It may show that you have become emotionally attached to the company—a potential blind spot to trouble in the future.
So how to handle stock splits? To Fisher Investments, it is as simple as this: Be aware of them, but don’t spend any time analyzing them. Don’t let them change your view of the company. They are zero sum for investors.
Time is a valuable commodity for all of us, and in investing, you want to make sure you are using it fruitfully. In Fisher Investments’ view, spending as little time as possible digesting the terms of a stock split is smart. Coverage of stock splits is more noise than news for investors, and we think it is far from news you can use.
Investing in securities involves a risk of loss. Past performance is never a guarantee of future returns. Investing in foreign stock markets involves additional risks, such as the risk of currency fluctuations.
This article reflects the opinions, viewpoints and commentary of Fisher Investments editorial staff, which is subject to change at any time without notice. Market Information is provided for illustrative and informational purposes only. Nothing in this article constitutes investment advice or any recommendation to buy or sell any particular security or that a particular transaction or investment strategy is suitable for any specific person.
