Share splits make a comeback

Article #739 by Edward Rizzo - Published Weekly

Since the start of the year, two of the big tech companies in the US announced that they will be splitting their shares in the coming months. On 1 February, Alphabet Inc (the parent company of Google) announced that it will conduct a 20-for-1 share split. Likewise, on 9 March, Inc also announced plans for a 20-for-1 share split.

When a company performs a share split, the nominal value of each share decreases and consequently the number of shares in issue rises. However, the total monetary value of the issued share capital remains unchanged and as such, this corporate action does not entail any dilution for shareholders. This means that the percentage stake held by each shareholder remains the same once a share split takes place. Since the number of shares in issue changes as a result of the decrease in the nominal value, the price in the market adjusts accordingly to reflect the increased number of shares in circulation. As a result, the company’s valuation also remains unchanged assuming that the adjustment in the share price would be exactly in line with the share split ratio.

On the contrary, a ‘reverse share split’ leads to a reduction in the number of a company’s outstanding shares. However, the same principles for a share split apply and thus both share splits and ‘reverse share splits’ do not leave any impact on the market cap of the company.

As such, if the shareholders of Alphabet Inc approve the share split in due course, each shareholder will receive 19 additional shares on 15 July for each share held as at close of business on 1 July. At current share price levels, this would imply that as from July, the share price of Alphabet will adjust from the current level of circa USD2,700 per share to USD135 per share.

In the same manner, with the Amazon share split due to take effect on 6 June, its share price should adjust to USD163 from the current level of USD3,255 per share as investors will obtain an additional 19 shares for every share currently held. This is Amazon’s fourth share split since its IPO in 1997. In 1998, Amazon conducted a 2-for-1 split followed by a 3-for-1 share split in January 1999 and a 2-for-1 split in September 1999. Amazon’s share price has grown in excess of 4,300% since the last split was announced in 1999.

The announcements by Alphabet and Amazon follow other large technology and consumer companies splitting their shares over recent years. In 2020, both Apple Inc and Tesla Inc announced similar share splits. Apple conducted a 4-for-1 share split in August 2020 and Tesla carried out a 5-for-1 share split shortly afterwards. The 2020 split by Apple was the fifth time that the company performed a share split since its IPO in December 1980. The previous share split by Apple was on a 7-for-1 basis in June 2014. In prior years, Apple had conducted a 2-for-1 split in February 2005, June 2000 and also in June 1987.

Some investors may be confused at the rationale for conducting share splits once the percentage stake held by each shareholder is not impacted.

The primary reason for conducting a share split is to increase the liquidity in an equity. Liquidity means the ease with which investors can buy or sell shares on a stock exchange.

If there are more shares in circulation at a lower price, the shares become psychologically more affordable which, in turn, generally translates into improved liquidity in a company’s shares which is an advantage for the market at large. For example, in August 2020, Apple clearly stated that its share split will help “to make the stock more accessible to a broader base of investors”.

Another important consideration for US companies to carry out a share split is to gain access to Dow Jones Industrial Average index since the weightings of the 30 constituents within this index are ranked by the absolute share price rather than by a company’s market capitalisation. The Dow Jones is a price-weighted index and not a market cap weighted index like the S&P 500 and most other renowned indices across the world.

Amazon and Alphabet are the third and fourth most valuable companies in the S&P 500 ranking behind Apple and Microsoft. Apple was added to the Dow Jones Industrial Average index in March 2015 only nine months after completing a 7-for-1 split, while Microsoft has been in the Dow since 1999. The last major shakeup of the Dow took place in mid-2020 when Salesforce, Amgen and Honeywell were added while Exxon Mobil, Pfizer and Raytheon were removed.

A recent study by one of the large US investment banks indicated that share splits generally lead to higher returns. This study found that once a split is announced, a company’s share price advanced by an average of 25.4% over the following 12 months.

A number of companies in Malta also conducted share splits over the years. The first share splits took place in 1994 by Bank of Valletta plc and HSBC Bank Malta plc (then Mid-Med Bank plc). At the time of the second major bull market in Malta in 2005 and 2006, HSBC Bank Malta plc, Lombard Bank Malta plc and Mapfre Middlesea plc all performed share splits to reduce the absolute share prices following the sharp upswing in their equities. Other companies also carried out share splits since then not only to enhance the liquidity aspect as a result of an upward movement in share prices but also to adjust the nominal value of a company’s shares following the adoption of the euro in January 2008. The share splits by Malta International Airport plc in 2010 and Plaza Centres plc in 2012 served this dual objective. Meanwhile, GO plc for example, which never conducted a share split over the years, has a nominal value of EUR0.582343 following Malta’s adoption of the single currency in 2008. The most recent share splits in Malta were conducted by Medserv plc (December 2013), RS2 Software plc (June 2015 and July 2016), Grand Harbour Marina plc (July 2015), and Santumas Shareholdings plc (November 2016).

In essence, share splits do not alter the fundamentals of the company in any way. Following a share split, the lower absolute share price does not imply that the company has become cheaper. Investors should continue to be guided by the financial fundamentals of a company by analysing various financial metrics and ratios before contemplating an investment. Investment decisions ought to be based on such financial metrics and not on the absolute price of each share and whether such a price-tag appears ‘cheap’ or ‘expensive’.

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This article was produced by Edward Rizzo, Director at Rizzo Farrugia, which is a company licensed to undertake investment services in Malta by the MFSA under the Investment Services Act, Cap. 370 of the Laws of Malta and a member of the Malta Stock Exchange. The company’s registered address is at Airways House, Fourth Floor, High Street, Sliema SLM 1551, Malta.