I once had the misfortune of sitting in a lunchroom while a man in his early 50s bragged to his uninterested colleagues about his unique ability to pick stocks. Included with his boastful comments was an explanation about the benefits of stock splits and details of how a company within his portfolio has had 2 stock splits within the past 15 years. “With these stock splits,” he bragged, “came an ensuing rise to the value of his portfolio.”
His colleagues, like myself, tried desperately to drown out the sound of his voice as he continued on about various strategies for trading stocks; but despite our best efforts, his droning came through.
For years, I successfully suppressed this traumatic event, until news of Apple’s recently announced stock split was awarded an entire column within the Business & Finance section of The Wall Street Journal. The article – touting a picture of an enthused Tim Cook – gives a historical overview of the advances in a stock’s price after a share split, and the likely benefits coming to Apple’s share price after their late August split.
The Reasoning Behind Public Corporations’ Stock Splits
While stock splits and other corporate activity have slowed over the past year, particularly due to the worldwide pandemic, there still seems to be a mass of excitement from these corporate announcements when they do occur.
This excitement surrounding stock splits seems to stem from a some displaced desire for action within the equities market as speculators grow anxious of having to sit still with their holdings. The same desire that similar minded people hope to satisfy by walking through a casino, anxious to hear the sound of a chiming slot machine.
This erratic behavior can be seen with other corporate actions as well. The announcement of an acquisition, the hiring of a new executive, or the plan for a buyback program all seem to arouse the animal spirits of the speculators residing on 11 Wall Street, NY. This commotion, of course, is rarely warranted.
An acquisition is only beneficial to the extent that the acquired company provides more value than the departing cash used to purchase it. A share buyback program provides value to remaining shareholders only when the shares are purchased for a price below their true value. Stock splits, peculiarly, are certain to provide no value or cause no harm to existing shareholders, something that can’t be said for most other corporate actions.
Years ago, stock splits were much more prominent as corporations aimed to keep their stock price around $100 per share to make purchasing blocks of shares easier and less costly as commissions were much steeper then. They have, over recent years, become much less common as digital brokerages have made purchasing shares virtually commission-free while also introducing new innovations such as the purchase of fractional shares.
It’s said by corporations that the reasoning behind such stock splits is to make it easier for retail investors to purchase into their company at a lower price; but of course this is rarely the case. More often than not, stock splits are done to satisfy those same speculators of lower Manhattan, as well as to entice the attention of a field of market participants.
Why Investors Find Stock Splits Irrelevant
However, all true investors understand that stock splits have no effect on the underlying value of a corporation. An increased number of shares does not lead to higher earnings, nor does it lead to a higher level of assets on a corporation’s balance sheet. It’s simply the financial equivalent of cutting a cake into multiple pieces and therefore making it easier to distribute. The cutting of the cake does not actually create more of the dessert.
The dangers of getting wrapped up in this wide-spread irrational behavior surrounding the promotion of stock splits is the temptation to participate in it, even if one knows doing so is based on unreasonable thinking. Few things are harder than resisting the draw of speculation as people brag about their consistent winnings, while attributing their success to talent rather than luck. They seem to quickly ignore the past results of market speculators and their inevitable downfall and cling to the false premise that “this time is different.”
While engaging in such behavior may result in a positive outcome 9 out of 10 times, the 10th time is likely to wipe out any gains made by the first 9. These facts, unfortunately, seem to do little to dissuade the irrational behavior within financial markets as the emotions of greed so frequently overpower the sanctity of rationality.
Shareholders of American corporations would be much better off if they were to ignore the noise of market speculators and arrive at their own conclusion on whether they are being benefited by corporate activities, or if such actions are a mere factor of speculative hype.
This article has been reprinted with permission from William Douthat’s Linkedin page.