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Tesla’s
TSLA,
upcoming stock split will likely amount to a lot of sound and fury, signifying nothing. I say that not simply because splitting is an accounting entry — though it is true that, after Tesla’s three-for-one split after the market closes on Aug. 24, shareholders will own precisely three times as many shares as before, with each worth one-third as much.
The reason Tesla’s stock split is little more than a distraction is that the rationales traditionally given for why splits are a good idea have either never been valid or no longer apply to the markets as they currently are structured.
Yet old wives’ tales die hard, and many continue to believe that it’s a bullish signal when a company chooses to split its shares. Tesla’s three-for-one split will be its second in as many years; the company split its shares five-for-one in August 2020.
The traditional rationales for why stock splits make sense all boil down to the notion that they are necessary to bring high-priced stocks back into a range that makes them affordable to retail investors. If that is indeed the case, then a stock split is a bullish signal, since it means that the company believes that, absent the split, their shares would not otherwise fall back into that range.
These rationales lost whatever plausibility they used to have when most of the large discount brokerage firms began enabling clients to purchase fractional shares. At that point, a small portfolio no longer was the hindrance to purchasing a high-priced stock.
This undoubtedly is why stock splits are so much less common nowadays. The frequency of stock splits has dropped by more than half over the past decade, despite a bull market that propelled many stocks to prices far higher than what previously was considered beyond the reach of small retail investors. An investment newsletter which used to recommend stocks that split — the “2-for-1 Stock Split Newsletter,” edited by Neil MacNeale — was forced to close in 2017 because, MacNeale wrote, “the lack of split announcements.”
In any case it’s not clear that, even prior to when fractional shares became available, splitting a stock leads to an increase in the proportion of shares owned by retail investors. I note a study from 20 years ago, in the Journal of Financial Research, which found that, in the wake of a stock split, there was a statistically significant decrease in retail investor ownership and a corresponding increase in institutional buying.
That’s just the opposite of what would be expected if you believe the traditional rationale for why stock splits are important. Entitled “The Effect Of Stock Splits On Liquidity And Excess Returns: Evidence From Shareholder Ownership Composition,” the study was conducted by Patrick Dennis of the University of Virginia and Deon Strickland of Arizona State University.
A similar conclusion was reached this May in a study by CBOE’s North American Execution Consulting Team. They focused on the potential impact of a split on both the stock as well as the options markets, finding that, based on “preliminary evidence,” it appears that “post-split lower prices do not necessarily attract significant additional interest in trading the securities.”
Announcement effect?
Yet long-held beliefs die hard. So it’s possible that investors could bid up the price of stock around the time its split is announced, in the mistaken belief that a stock split remains the bullish signal it once was.
Yet I could find no evidence of this announcement effect. Consider what I found upon measuring the performance of the 20 stocks in the S&P 500
SPX,
that have split their shares at any time since the beginning of 2020. (I only focused on forward splits, ignoring reverse splits, which are thought to be bearish.) For each I calculated the stock’s “alpha” (return relative to the S&P 500) over a period beginning a month prior to the split’s ex-dividend date and lasting until one week past that date. For the 20 stocks as a group, their alphas were statistically indistinguishable from zero.
The bottom line? Stock splits have become largely meaningless distractions. One wonders what a company’s motivation might be to nevertheless incur the considerable expense of splitting its shares, other than to divert attention from less-than-favorable news that might otherwise dominate investors’ attention.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com
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