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Tesla 3-for-1 stock split explained

by LLB Reporter
25th Aug 22 11:25 am

Companies largely think a share split helps liquidity in their shares, in the view that a big share price can be a deterrent to private investors in particular – Amazon carried out a 20-for-1 split for exactly this reason in the summer. The argument is that it helps investors with smaller portfolios, who find it harder than big pension funds or the big institutions who run huge pools of money, to run a diversified portfolio if just one share costs a lot of money.

Investors often accept such thinking, following the logic that the split will create a tidal wave of buyers who will drive the stock higher. But for every buyer there has to be a seller. The issue is the degree of intent and commitment. If the buyers are more determined, the stock might rise in the short term and fair enough.

Ultimately, however, nothing really changes except the share price and the share count.

In light of the impending stock split from Tesla this week, AJ Bell investment director, Russ Mould, comments: “In Tesla’s case, the 3-for-1 split means investors will own three Tesla shares for every one that they own now. But the share price will correct and drop accordingly, so the company’s total market capitalisation stays the same and the monetary value of the shareholder’s total investment in Tesla also stays the same. All other things being equal, so does the investor’s percentage stake in the company.

“A split is really just a cosmetic exercise and one that in no way changes the fundamentals of the company, or the investment case for it. The core of the investment case, in turn, will always rest on the competitive position of the company, its financial strength, management acumen and then valuation. Not one of those changes in the case of a stock split. The share price adjusts down and nothing much else, barring the share count, changes. As a result of this, in theory, the shares are more liquid because there are more of them and are thus easier to trade.

“But again, that does not make the firm a better investment. As Warren Buffett is always misquoted as saying, his favourite holding period is forever, so if the company is a good investment, why should you worry about being able to nip in and out to trade its shares?

“And don’t forget that in 2008 you couldn’t trade FTSE 100 stocks that easily, no matter how many shares they had in issue, because everyone thought the world was ending and there were no buyers.

“Liquidity is not how many shares you have in issue. For an investor, liquidity is being able to buy or sell when you want, in the company you want, at the time you want and in the size you want. And the share count won’t make any difference to that the next time there is a market panic on, either.

“The other danger is that share prices tend to get big after long upward runs, so stock splits can sometimes be very common near what proves to be a market top. I wouldn’t at all be surprised to see more management teams embrace stock splits, in some cases perhaps quite cynically to try and create fresh share price momentum, but over the long-term fundamentals will matter more than cosmetic issues such as this.”

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