Investors love stock splits because they seemingly make the price of a single share of a popular company more affordable. That's largely a psychological thing because when a stock splits no value has actually been created and nothing has really changed except the number of shares.
A stock split works a lot like slicing a cake. If you cut it into eight slices, 12, or even 20, you still have one cake. In reality, though, dessert restaurants make more money selling a cake by the slice than they do selling a whole one.
In the case of a stock like Alphabet (GOOGL), the parent company of Google, which plans to split its stock on a 20-for-1 basis, that's at least partly the logic behind the move. Shares in the company trade at around $2,700 as of 9:30 a.m. on Feb. 2. After a 20-for-1 split, one share would cost $135.
More people can afford $135 than can afford $2,700. That shouldn't matter as much as it did a few years ago as most brokerages, including the popular Robinhood (HOOD) platform allow customers to buy fractional shares. In theory, buying 1/20 of a share of Google/Alphabet equals buying a full share after the split.
In reality, many investors/traders likely don't feel the same way even if they fully understand that math.
Image source: Ron Jenkins/Getty
Stock Splits Don't Change Valuations
"From a pure accounting standpoint, stock splits have no impact on the valuation of a stock," wrote James "Rev Shark" DePorre: Real Money Contributor and Founder of Shark Investing. "It is simply the equivalent of cutting a pizza into more slices."
Not having an impact on valuation isn't the same as not having an impact, however.
"Stock splits can have a dramatic psychological impact," wrote DePorre. "The theory is that an expensive stock can now be more easily bought by a greater number of people when it is trading at 5% of its prior price. It also can create the illusion that the stock is now ‘cheaper’ simply because the price tag is lower, although valuation remains the same."
And, even though it's possible to buy fractional shares, DePorre noted that being able to do that does not make a company investable for some traders.
"Many brokers now offer the ability to buy fractional shares, which removes some of the emotional impact of a stock split, but retail investors tend to have a bias toward owning lower-priced stocks simply because they like the idea of owning more shares," he wrote. "Traders often prefer holding 100 shares of a lower-priced stock rather than just five shares of higher-priced stocks, but that is mainly an emotional bias," he wrote.
Why The Google Stock Split Might Matter
And while stock splits are often done for appearance or emotional reasons, Chris Versace: Thematic Investor and Co-Portfolio Manager, Action Alerts PLUS, thinks that Alphabet's may serve a bigger purpose. He noted that the company's move may be about helping the company get itself added to the Dow Jones Industrial Average.
"Normally stock splits are more cosmetic in nature, but in the case of Alphabet it does offer stock price shy investors the chance to get into the shares but arguably the more interesting development to watch will be potential inclusion in the Dow Jones Industrial Average," he wrote. "I say that because inclusion would mean that any exchange-traded products that map to that index would be buyers of GOOGL shares."
There's also one other reason that companies, and perhaps Alphabet's stock split may matter, according to DePorre.
"There is some academic research that shows that stock splits are often used by managers as a method to convey optimism about company operations," he wrote. "There is also data that shows that stocks that split tend to have better profitability, returns, and liquidity in the year after the split. This is self-fulfilling to some extent, but there is a positive correlation between splits and stock performance in the short term."
