Updated: August 24, 2020
Tesla (TSLA) recently announced that they’re doing a stock split. It will be the first time for the company, whose 5-for-1 stock split will take effect on August 31, 2020.
Interestingly, on the same day, Apple (AAPL) will also do a stock split, 4-for-1 in their case. For long-time Apple shareholders, this isn’t new as the company has done this several times, the most recent one in 2014 when they did a 7-for-1 stock split.
Stock splits are a rare occurrence in the Philippine Stock Exchange. Nevertheless, it’s important to know what it is especially if you’re trading and investing in the global markets.
What is a stock split?
All companies that are publicly traded have a certain number of outstanding shares.
So, let’s say a publicly-traded company is worth $1 million and ownership of that company is divided into 10,000 shares.
If we divide 1 million by 10,000, then we’ll see that each share is worth $100.
After a while, this company did massively well as a business and their revenues grew tremendously. Now, the company is worth $10 million.
If we divide the company’s current worth of 10 million by the 10,000 outstanding shares, then we’ll compute that each share is now worth $1,000.
Remember that this is a company in the stock exchange. So, if you’re an average investor and you want to buy shares of this company, then it would be expensive because you’d have to shell out $1,000 just to buy one share.
That’s what the management also thought, so they decided to do a stock split. Say, a 5-for-1 stock split.
This means 1 share will split into 5 shares. Thus, from 10,000 shares, there will now be 50,000 outstanding shares.
If you previously owned 5 shares of this company, then you’ll receive 20 additional shares and end up with a total of 25 shares after the stock split.
As for the share price, that, in turn, gets divided into five. So, from $1,000 it now becomes $200 per share — a price that’s more affordable to an average investor.
Previously, you owned 5 shares at $1,000 each. After the stock split, you now own 25 shares at $200 each. Nothing really changed in the value of your investment, which is okay.
That’s basically what a stock split is. Or more accurately, what happens during a stock split.
So, a stock split is when a company divides the existing shares of its stock into multiple new shares, while its price per share adjusts to retain the company’s total value; which in turn also retains the total value of what each shareholder has.
Why do companies do stock splits?
If stock splits do nothing for the value, why do companies do them? As mentioned above, companies do these to make it easier for the average investor to buy shares.
For example, take Ayala Corporation (AC), which is trading at P750; and Ayala Land (ALI) which is trading at P40.
To own shares of AC, you need to buy the board lot of 10 shares, which will cost you P7,500. However, the board lot of ALI for its price is 100 shares, which means you only need P4,000 to own its shares.
If you only have P5,000 to invest in the stock market, then you can only afford to buy ALI and not AC.
But what if AC did a 10-for-1 stock split? Then each share price will go down to P7.50 and the company’s board lot will become 100 shares. Thus, you’d only need P750 to buy Ayala Corporation.
In 2014, when Apple did a 7-for-1 stock split, CEO Tim Cook said, “We’re taking this action to make Apple stock more accessible to a larger number of investors.”
Other than this reason, some companies do stock splits to help with their liquidity.
At the end of the day, stock splits are simply cosmetic changes to how ownership of a company is held, which is why fewer companies are doing them.
What investors must remember when stock splits happen
Stock splits don’t change the fundamentals of the business at all. So, it’s incorrect to think that a stock split automatically means good news for the company.
Some people might say that stock splits are a bullish sign because it means the company thinks they’ll keep growing and the share price will continue to go up as well.
However, the truth is it can go in either direction.
There may be some short-term movements related to the news. But long-term, shares move because of the business results that companies put up, not the number of ways ownership is sliced up.
Most analysts are now saying that there are strong reasons that Tesla’s price would continue to go up.
Among them are its continued global expansion, the sustained increase in its product demand, and the possibility that the company would be added to the S&P 500 Index.
At present, Tesla shares are at around $2,000 per share. After that 5-for-1 stock split, the price per share will change to about $400 per share.
However, you don’t need $2,000 to invest in Tesla. And you don’t need to wait for the stock split to buy Tesla shares at $400. Because at eToro, you can buy fractional units of shares of U.S. companies.
This means even with only $200 in your account, you can just buy 0.10 units of Tesla. Or if you want to wait for the stock split, then your $200 can give you 0.50 units of this company.
Lastly, did you know that you can invest in Tesla risk-free today? Just create a virtual account and experience how it is to invest in U.S. stocks today.
Risk Disclaimer and Disclosure:
The content discussed in this post is intended for educational purposes only and should not be considered as investment advice. Past performance is not an indication of future results. Moreover, eToro is a brand partner of this website.