The Truth About Stock Splits

What is a stock split?

Investopedia defines a stock split as:

• A corporate action in which a company issues additional shares to shareholders, increasing the total by the specified ratio based on the shares they held previously

How does a stock split practically work?

I think the easiest way to explain stock splitting with an example. Let’s say we have a company called Acme Inc. It has a market cap of $100,000,000. They have 10,000 outstanding shares which gives us

• $100,000,000 / 10,000 shares which means their shares are worth $1000 per share.

For various reasons they may choose to issue a stock split. If a 10:1 stock split was chosen they would end up with:

• 100,000 shares
• the market cap stays the same
• all shares outstanding are now worth $100 each

Now why would Acme Inc. choose to 10x the price and 1/10th the cost of each share. Personally I believe a big part of it is pure psychology. $1000 can be a huge mental hurdle and deter potential investors. There’s a reason almost everything at the grocery store is priced ending in .99 or .49 and why Walmart undercuts this even further often ending their prices in .97. The reason is perception, it gives the consumer the feeling of getting a good deal or something appearing “cheap”.

Perception is a huge deal, especially when taking into consideration the average earnings of their investors. Let’s take a look at some relatively current Canadian Statistics. Trading Economics has the average weekly earnings of Canadians at $1252.85 as of June 2024. source. Turn that into a monthly figure of ~$5000. Now using the 6.9% average savings rate from Q1 2024 source we arrive at $345 savings a month. This means the average Canadian would be only able to purchase about 4 shares a year. That is also assuming they are comfortable investing all of their money in a single stock. Talk about a lack of diversification.

Pros to stock-splits

1. Psychological appearance of a stock being “cheap” or not as “expensive”. To reiterate from above, while this is not mathematically true, If I order a large pizza and it comes sliced into 8 pieces and I then slice every piece in half I still have the same amount of pizza. I still paid the same amount for the full pizza.
2. Not many Canadian trading platforms offer fractional share purchasing. A cheaper price may mean you are able to buy more frequently and thus take advantage of dollar cost averaging into your selected stock. - Wealthsimple
   • If you are interested in Wealthsimple please use my referral code and you will receive a $25 bonus for signing up - Interactive Brokers - TD (was just released in the last couple of months)
3. If you enroll in a dividend re-investment plan (aka DRIP) you don’t need to have as much money invested to drip a singular share. - As an example of this I invest in VTI in my RRSP and one day I would like to be able to DRIP a full share but based on the current dividend percentage and price I would need around $100,000 CAD invested.
4. While not all but many platforms are offering fractional share buys and sells even fewer are offering fractional dripping - To my knowledge the only platform that currently offers this is Wealthsimple in Canada
5. Publicity, stock splits are pretty straight forward and should’nt have any effect on stock price but it at the very least puts the stock on more peoples radar. Just take a look on YouTube over late September up to now everyone has been talking about the big Charles Schwab funds. Which brings us to our next section.

Cons Fractional Shares (aka the alternative to stock splits)

1. Can only be listed at market price. So you aren’t able to set a limit price.
2. Transferring between brokers may be more complicated if one supports fractional shares and the other doesn’t
3. Your portfolio doesn’t look as “clean”. This is likely a me problem, I can be slightly OCD at times, I have a .0001 share of HXQ in my Wealthsimple account that irks me every time I scroll past it.

Whether we have to go the fractional share route or companies continue to issue stock splits one thing is certain to me, high price per share stocks only harms the individual investor.

ETF Stock splits

Yes even ETFs sometimes receive stock splits and in recent news as eluded to earlier the market received a news release from Schwab on September 25th. The release announced forward share splits on 20 of their ETFs

• Their highest priced ticker SCHG will bet getting a 4:1 split
• My personal favorite fund of theirs that I am invested in SCHD is getting a 3:1 stock split
• Majority of the rest are receiving a 2:1 split
• Full announcement here

The ETF giant Vanguard split a handful of ETFs in 2023 and a couple back in 2021. Mostly small cap / Russel Index related. Personally I hope they announce stock splits on their two largest funds VOO and VTI but until then I will continue to buy a few shares at a time of VTI.

Reverse Stock Splits

You may be thinking to yourself if one can split stocks to lower their share price can you split the other way reducing outstanding shares and thus increasing the share price the answer is yes!

Reasons for a Reverse Stock Split:

• Minimum stock price enforced by an exchange
  • NYSE requires a prices above $1.00. If a stock closes below that for 30 days in a row it will be de-listed.
• To “Improve” share price
  • In the US if a stock trades at or below $5 it is referred to as a penny stock and not deemed investment grade. Easy way around that reduce the total number of outstanding shares
• Maintaining share price after splitting a business into multiple separately traded entities

Summary- my thoughts

Personally I believe stock splits are healthy for the everyday investor and still needed. We may one day have fractional shares accessible to all and have fewer limitations but until then keep the forward splits coming!