You've just heard that a stock you own is splitting. Should you be glad about it?
Some of the biggest stocks in the market have split in the past couple of years. Amazon.com made a 20-for-1 split in June 2022. Broadcom split 10-for-1 in July. And Microsoft divided its stock 2-for-1 on March 7, 2023, increasing its shares outstanding at the time to 10.8 billion.
The immediate effect on your wealth is zero. However, stock market history shows a company's decision to split shares often indicates management is getting overly optimistic about the near-term future.
When bullishness in a stock gets overblown, watch out for a substantial decline in the stock to follow — especially if it has outperformed the market for many months.
Why Stock Splits Occur
The premise for a traditional, forward stock split is simple. If the price of a stock is $100 a share, a 2-for-1 split would cut the share price in half, making it more attractive to smaller investors. Existing stockholders would receive two shares for each share owned. The total monetary value of all holders' shares doesn't change.
One benefit of a stock split? It gets media attention. The news puts the company on the radar of more investors and potential new buyers. Another benefit is that liquidity, or the ease with which shares can be bought and sold, tends to increase. Institutional investors generally favor stocks with higher trading volume as it can reduce the costs of building a large position and of selling shares.
Share splits naturally take place after a stock has gone on a brilliant run. But Investor's Business Daily's stock-market research finds excessive splits — such as 4-for-1 or multiple splits within a year — take place when a stock goes into the final stage of a long-term advance. Splits can flood the market with extra supply of shares, which can overwhelm buyers. This means savvy investors should treat splits as a time to be on guard for signs of a price peak.
Qualcomm's Lesson In Stock Splits
The late 1990s, when technology stocks soared to high prices and valuations before the dot-com bubble burst in March 2000, serve as a wonderful example of how stock splits can be a signal for investors to be wary.
Qualcomm, arguably the best growth stock of 1999, broke out to new highs early that January. Shares rushed past the $60 level and almost quadrupled in price by May. The S&P 500 went from 1229 at the start of 1999 to 1375 by May 14, a pedestrian 12% gain by comparison.
On May 11 that year, the wireless-tech firm held a 2-for-1 stock split. The decision seemed logical; if the company didn't split shares, investors might blanch at the prospect of purchasing shares at more than $220 apiece.
Qualcomm shares went on an even stronger run after the split. From its lowest post-split price in May, the tech giant rallied more than ninefold. On Nov. 2, the company's board approved a 4-for-1 split in its common shares.
That 4-for-1 split proved to be excessive. It took place on Dec. 31, 1999, the final trading day of a white-hot year for tech stocks. Qualcomm's new post-split peak of 200 arrived just two sessions later. By late January, the stock fell below 106, and by early July, it hit a low of 51.50.
The 2020s: Decade Of Supersized Splits
In the 2020s, some large and megacap companies have conducted share splits amid a longer-term bull run. Whether these splits will pay off over the long term is an open question, but the divergent early returns for two of the biggest point to risks of buying a hot stock after a split.
Google owner Alphabet conducted a 20-for-1 split in July 2022. In that year, amid an aggressive campaign by the Federal Reserve to raise interest rates to tame inflation, Alphabet shares had dropped as much as 45% from their peak, and they continued to fall after the stock split.
Yet as the company's revenue and earnings grew, Alphabet shares made a remarkable comeback starting in early 2023. They hit a record high in mid-July, before retreating since July.
Then there is Chipotle Mexican Grill, which executed one of the biggest stock splits of all-time, at least among S&P 500 firms: a 50-for-1 swap in late June.
In the days right before the split, Chipotle traded at more than 3,400 a share and hit a record closing high.
Was the split a warning sign? Time will tell. But currently Chipotle stock is trading about 20% below its close on the day the split went into effect, including the hit shares took when news of its chief executive's exit became public.
