So far, 2022 has been quite the year. In previous articles, I have written about the reasons why the market is down, some of the ways it could improve, and a historical perspective on how this year compares to history. This month, I want to introduce the idea of stock splits because several big-name companies have done them recently, and several more are scheduled to do so later this year. The fact that these companies are splitting is important, and the impact of doing these splits should be significant to the market in my opinion.
Due to compliance, I am unable to name specific companies throughout this article, so I will do my best to explain this topic without going into specific companies or naming any names.
What is a stock split? Investopedia defines a stock split as “an increase in the number of shares in a corporation’s stock without a change in the shareholders’ equity.”
Companies often split shares of their stock to make them more affordable to investors. It is important to note this does not issue more shares, so it does not dilute the ownership interest in existing shareholders. For example, in a 2:1 stock split, existing stockholders receive two shares for every one they currently own. Company A could execute a 20:1 stock split, meaning shareholders would receive 20 shares for every one share they own. The share price would go from around $2,000 a share to around $100 a share. If an investor owned one share prior to the split, the value of that share, and therefore the value of holding, could be $2,000. After the split, the investor could have 20 shares worth $100 apiece, therefore keeping the value of the portfolio at $2,000.
Why do companies do this? They do this for many reasons. For one, a smaller price per share should allow more investors to buy the stock, therefore increasing demand, and as a result, increasing the price per share. This also impacts the options market. Most Americans have heard of the options market, but don’t have a real understanding of how it works. While I won’t go into full detail here, I will try to explain the basics of how stock splits impact the options market.
Options sell in “round lots.” A round lot is 100 shares. You can participate in the options market only by buying or selling in round lots. If a stock is trading at $3,000 a share, then 100 shares of that stock is $300,000, so the round lot would be $300,000. That price eliminates several potential investors who can participate in that market. After that same 20:1 split, that same company was trading at around $100 a share, making their options contracts a more affordable $10,000 per round lot.
We have seen several stock splits going back to 2020 on some of the biggest companies in the world. Some of these splits have been significant, like a 20:1 split. I think this is important because as the demand increases for these companies, the stock price increases, which may improve the market overall.
In 1999, there were about 5,500 publicly traded companies, and most of you will find it surprising that there are only about 4,000 today. Most people I talk to assume the number of publicly traded companies have increased significantly over the past 20 years. The number has gone down, making it a more volatile market. If a baseball team loses three key players, the performance of the team is more dependent upon the remaining healthy players. In other words, so goes the remaining healthy players, so goes the team.
In the market, we have less companies to depend on for performance, meaning so goes a few companies, so goes the market. Several of these companies that lead the market have executed stock splits, and using history as our guide, companies tend to perform well after stock splits, meaning when we ultimately recover from this current market downturn, these splits should be a big reason why.
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