Stock splits are all the rage - After Google announced in Feb that there would be a 20:1 stock split in July this year, Amazon has followed suit announcing a similar 20:1 split and sending the market into a frenzy. Amazon’s price was up by 6% the next day and Google’s stock rose more than 9% in after-market trading following the news. Tesla is also planning for a second stock split and most recently, GME has also announced its stock split.
We do know that stock splits do not affect the underlying business in any way, but it is undeniable that there is price movement around the announcement and execution of a stock split. So in this week’s analysis, let’s deep-dive into the world of stock splits, how and why they are executed, and most important… Is it possible to make money off of a stock split?
What is a stock split and how is it executed?
A stock split is a simple decision by the company board to increase (or in some cases decrease) the outstanding shares of the company. For example, let’s say you own 10 shares of company X worth $100 each. So in total, you own $1K worth of shares in the company. If the company announces a 2-for-1 stock split, now you will have 20 shares of the company worth $50 each. But the total value of shares you own in the company does not change. You will still own the same $1k (20 x 50) worth of shares that you started with.
If you are wondering why companies engage in stock splits, the following are some of the key reasons.
- Affordability: Sometimes the stock becomes too expensive for retail investors to buy into. Consider Amazon - One stock is worth close to $3k now. So the minimum amount you would need to start investing in Amazon is $3k which might not be affordable to a vast majority of retail investors \[1\] Also there is the psychological impact of buying a share worth $3k and a share worth $30.
- Options: For the options players, there is a huge difference when a stock is cheap. In options, a single contract is worth 100 shares. So for a covered call strategy incorporating Amazon, before stock split, you would need a single stock position worth more than $275K vs only \~$14K exposure after the said 20:1 stock split.
- Liquidity: Since more shares are outstanding for the company after the split, it will result in greater liquidity and a lesser bid-ask spread. It also allows the company to buy back their shares at a lower cost since their orders would not move up the share price as much, due to higher liquidity.
Now before we jump into the analysis, you should understand how exactly a stock split is executed. On announcement day, investors get to know that a stock split is going to happen soon. The stockholders eligible for the stock split are decided on the record date. This is mainly a formality. The actual split would happen on the ex-split date (or ex-date). After this, the stocks would start trading at their new price. For example, in a 20:1 split, the stocks would trade at 1/20th the previous price after the ex-date. From our data, we observed that there was an average delay of 36 days between the announcement day and ex-split date.
Data
For this analysis, I have used the data from Fidelity’s stock split calendar that tracks the announcements and execution of stock splits, from as far back as 1980! I have considered splits only from 1993 (due to stock price data availability), and I have considered only companies that currently have a market cap of $1Billion or above. I have also ignored reverse stock splits as the data is too small to be statistically significant.
This gives us a total of more than 2,000 stock splits to work with. In case you are interested in the raw data, I have shared both the raw data and analysis through links at the end \[2\].
Returns
As soon as a stock split is announced, there is bound to be a lot of buying and selling activity. The question i