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Do stock splits add up?
Companies with very high share prices sometimes consider stock splits. Do they make sense? John Stepek explains.
Amazon's stock has ticked over $1,000 for the first time
(Image credit: 2014 Getty Images)
Until this week, only four publicly listed firms in the US had share prices of above $1,000, notes Lex in the Financial Times. Now, tech giants Amazon and Alphabet (Google's parent company) look set to join the club, with Amazon shares scraping past $1,000 for the first time on Tuesday. Your initial response to this may be: "So what?" The price of a single share alone tells us nothing about the value of a firm. A company with ten shares trading at $1,000 each has the same market value as one with 1,000 shares trading at $10 each.
Yet not so long ago companies regularly conducted "stock splits" to prevent their share prices from rising too far. This is as simple as it sounds you swap one share for two or more, and the price falls accordingly (ie, if Amazon did a two-for-one share split at $1,000, owners would get two shares worth $500 each for each existing share held).
Each owner still owns the same percentage of the company as before they just have a larger number of shares. So far this year, only two S&P 500 firms have split their stock, according to Birinyi Associates, quoted in The Wall Street Journal. Last year, it was just six in total. Yet in 1997, 93 S&P 500 companies split their stock.
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So why the big drop? And why did companies ever split their stock in the first place? One argument is that stock splits make shares more liquid (easier to buy and sell). A share price represents the effective minimum investment in that company. At $1,000 a piece, that can be prohibitive for smaller investors. On this view, this mattered more in the heady days of the 1990s tech bubble, when day trading was popular and trading commissions high. Today, with low commissions and small investors more interested in buying index funds than frenetically trading tech stocks, splitting is no longer important.
That's one take. An alternative is that the popularity of stock splits may have been built on nothing more than tradition. "The Nominal Price Puzzle", a 2007 paper by a team including behavioural economist Richard Thaler, could find no practical benefit to stock splits, and pointing to their specific popularity in the US concluded that companies only continued to use them because it was the "norm" in the US.
Norms change over time and, as Matt Levine notes on Bloomberg, "now the way to signal normalcy is with financial rationality, and there's no rational reason to care about stock splits". We suspect that, markets being markets, rationality will fall out of fashion and things will change again in the not-too-distant future.
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