Monday may have been a slow news day, but for investors, it was a day to remember.
Because as markets opened on Monday, both Apple Inc. (AAPL) and Tesla Inc. (TSLA) stock were suddenly trading at prices much lower than they had closed at on Friday afternoon.
The two stocks had finally hit their long awaited “stock splits.”
Financially, stock splits mean absolutely nothing. They are completely irrelevant.
But psychologically, in this instance, it seems that the splits mean a bunch.
In fact, despite the mad rush up so far, Tesla and Apple could both now surge by 33%.
Stock Splits Mean Nothing – and Everything
Stock splits are not nearly as complicated as Wall Street makes them sound. You can think of them a bit like splitting dollar bills.
For example, say you have one $20 bill in your pocket, but you want to have a bit more flexibility in how you spend it.
So you split it into four $5 bills.
You’ve just done a 4-for-1 split, just like what Apple did.
Your total amount of money remains the same, $20. But now you have it in four pieces of $5, instead of one piece of $20.
Similarly, Apple split every one of its shares into four new shares, each new share worth one quarter of the old share. Say you owned one share of Apple on Friday. It would have been worth about $500.
When you woke up on Monday morning, that share would have been replaced with four Apple shares, each worth about $125.
In total, you still own $500 of Apple shares. It’s just been spread out over more shares, just like four $5 bills still add up to the same as one $20 bill.
Tesla did much the same, except its split was 5-for-1. Each old share was turned into five new shares, not four like Apple.
In both cases, the total value of all the shares, the market cap, remain the same. It’s why some analysts are saying this is a total nonevent.
After all, you wouldn’t go around bragging that you’re much better off now that you’ve split your $20 bill into four $5 bills.
And they’re right. Financially, stock splits don’t matter one bit.
But stock markets are not just about finance. At the end of the day, stock markets are traded by humans, or by algorithms created by humans.
Yes, you have to look at the financial side of things to be successful at trading and investing. But you also have to know the psychology of the humans responsible for all the trading.
And psychologically, stock splits can be catalysts for huge gains…
History Shows Stock Splits are Catalysts for Bull Rallies
Whether Wall Street likes it or not, the fact is that people prefer to trade and invest stocks that are cheaper.
Paying $500 for a share of Apple is a huge barrier to entry for regular investors looking to add just a little bit to their portfolio at a time. Tesla’s pre-split price of $1,875 was even worse, not to mention Amazon.com Inc.’s (AMZN) price of almost $3,500 a share.
Even though most stock brokers allow you to buy fractions of a shares nowadays, a large share price is still a psychological barrier. For options traders, it’s even worse, as there are no widely available “fractional” options around.
So some analysts think stock splits encourage more regular investors to buy the stock, leading to a post-split rally. Others say that’s a myth.
Well, Monday marked the fifth stock split in Apple’s history. That gives us a lot of data to look at.
And according to research from Morgan Stanley (MS), Apple tends to do very, very well after its stock splits, as you can see in this chart:
Not only does Apple stock tend to go up both before and after stock splits (blue bars), but it also tends to do better than the wider market, as measured by the S&P 500 (yellow bars).
And don’t worry about that -3.7% performance six months after the split. This is chart shows the median performance, so it’s heavily influenced by the company’s June 2000 stock split that was followed by the dotcom crash.
A look at Apple’s stock performance around the 2014 stock split shows a much better picture:
As you can see, in 2014 Apple shares did great before and after the split, and solidly outperformed the S&P 500 too. And remember, the 2014 stock split happened as investors were eagerly anticipating the launch of Apple’s long-awaited iPhone 6, after a few years of very small iPhone upgrades.
That mirrors this year quite well, as the upcoming iPhone 12 is rumored to be the first one equipped with 5G, and potentially a host of other new technologies, after years of incremental upgrades.
Based on this, we should expect Apple at least to go up by at least double digits in the next few months.
But the reality could be even better…
Here’s Who’s Next
Recently an analyst from investment platform eToro who looked at 60 years of stock splits from ten “megabrands” such as Apple, Amazon, Intel Corp. (INTC), and so on.
He found that these companies tend to do much better than 10-20% after a split.
On average, they rise 33% in the 12 months after stock splits. And with Apple and Tesla both being hugely recognizable brands with a devoted following and lots of anticipation for their new product launches, this seems quite likely.
In short, buy both stocks on any significant dips, because they will keep climbing now that the barrier to entry has been lowered. I like TSLA at around $400 (it almost got there this morning!) and AAPL on pullbacks to $125.
And this crazy jump in these two company’s stock prices is likely to push other companies to consider splitting their stocks, too.
Amazon is the most likely candidate here. At almost $3,500 a share, it’s the second-most expensive U.S. stock after only Warren Buffett’s Berkshire Hathaway Inc. (BRK).
That practically rules it out from being included in the Dow Jones Industrial Average, or “the Dow.” See, unlike most other stock indices, the Dow is weighed by share price, not market cap. That means that Amazon’s high share price would overwhelm the other companies in the Dow, making the index useless.
But if Amazon were to split its stock, its position as one of the single most important companies to the U.S. economy right now would make it likely that it could earn a spot in the Dow. With that would come a new wave of investors, as many funds that track the Dow would now have to start buying Amazon shares.
Not to mention the outperformance for megabrands that comes after stock splits, as eToro found.
Another candidate is Alphabet Inc. (GOOGL), Google’s parent company. At over $1,600 a share, it also is too pricy for most regular investors, as well as the Dow.
However, instead of splitting its stock in 2012, Google decided to issue a new class of shares without any voting rights, trading under the ticker GOOGL. That’s been a controversial move, and could dampen trader enthusiasm for future Google stock splits.
Amazon remains the more likely candidate, and a better bet on post-split performance, too.
There are plenty of other candidates, and I’m sure the boards of companies like CMG, NFLX and NVDA are doing more than just “monitoring the situation”. In fact, all three of those stocks were up big yesterday as TSLA did its moon shot. If your portfolio has room, buying all five of these stocks (AMZN, GOOG, GMG, NFLX and NVDA) on pullbacks is a good prep for future split news.
Great trading, stay safe out there, and God bless you,