“Stock split” can be an unwelcome phrase to a shareholder, especially one who is unfamiliar with financial terminology. Merriam-Webster defines split as “to divide into parts or portions: such as to divide between persons.” Dividing between persons sounds like taking from one person to give to another, something shareholders unfamiliar with stock splitting will likely shy away from. This article provides guidance to organizations on the basics of stock splits as well as how to explain a stock split to a key subset of shareholders for many startup firms: the employees.
What is a Stock Split?
Imagine that ten years ago an investor purchased a share of stock for $100. After ten years of growth and successful business operations, the stock now trades at $1,000 per share. At this elevated price, the corporation recognizes that it is losing potential new investors who do not want to buy in at the high price per share. To solve this issue, corporations may decide to split the stock. In a two-for-one stock split, the shareholder who holds one share of stock valued at $1,000 would have her share split into two shares of stock valued at $500 each. Thus, the total value of her holding with the company is unchanged. Before the split, the shareholder held one share valued at $1,000 and now the shareholder holds two shares valued at $500 each. This is exactly like trading one $10 bill for two $5 bills.
Why Do Companies Split Stocks?
The decision to split the stock is ultimately a strategic move guided by the board of directors to make the stock more liquid, attractive, and attainable to investors (Forbes). A stock trading at $1,000 might be too expensive for some potential investors, but a two-for-one split to drop the price to $500 per share may make the shares more affordable.
Apple has averaged a stock split every eight years since going public in December of 1980. “The stock split on a 4-for-1 basis on August 28, 2020, a 7-for-1 basis on June 9, 2014, and split on a 2-for-1 basis on February 28, 2005, June 21, 2000, and June 16, 1987” (Apple). When asked what he thinks about stock splitting, Apple’s CEO Tim Cook is quoted as saying: “Hey, I want more people in the stock.” CNBC’s Jim Cramer has praised Apple in the past for caring about the “little guy” when it comes to managing its stock price per share (CNBC). So far, caring for the little guy seems to be working for Apple. According to a Yahoo! Finance article, $1,000 invested in Apple in 2011 would be worth close to $11,000 today (Yahoo! Finance).
Other companies, such as Airbnb, split privately-held stock to prepare for an initial public offering. A reason for splitting the stock prior to an initial public offering could be that the value of the stock’s price per share will be too high to entice new investors when the stock first hits the open market. Because most companies going public want to raise a certain amount of capital, it’s important that a high stock price per share not drive away investors. In the case of Airbnb, the fair market value of the stock had risen 10.4% from the end of the second quarter to the end of the third quarter of 2020 according to reports with Bloomberg (Bloomberg). Accordingly, Airbnb’s board of directors decided to split the stock on a two-for-one basis prior to the IPO. The split reduced the price per share from nearly $70 to $35. Even after the split, Airbnb’s shares still debuted at $68 per share due to high investor demand, increasing the price of the stock.
On the other hand, Berkshire Hathaway is the famous counterexample for splitting stocks. On the morning of November 1, 2021, Berkshire Hathaway’s class A stock opened at $434,513.00 per share, a price so high that Nasdaq computers were unable to record it (Yahoo!). Although this extremely high stock price per share is out of reach for most potential investors, Buffett remains firm in his resolve to not split the Class A shares. Buffett claims that Class A shares will never be split because he thinks that high share prices attract like-minded investors who are focused on long-term profits as opposed to short-term price movements (TheStreet). Although it appears that Warren Buffett will never split the company’s Class A shares, in 1996, Buffett did make his stock more accessible by creating Class B shares of Berkshire Hathaway. Part of the reason Buffett created Class B shares was to “outfox fund managers who wanted to set up mutual-fund like structures that would sell slices of the company in smaller pieces” (WSJ). At inception, the Class B shares were worth 1/30th of a Class A share. Buffett then split the Class B shares fifty-for-one in 2010 to help pay for a large acquisition of a railroad company (WSJ). The Class B shares are now worth 1/1500th of the Class A shares making it more accessible to average investors.
Buffett’s strategy is interesting. With the Class A shares, he attracts long-term, stable investors while the Class B shares are accessible to average investors and allows for more speculative trading. Tarek Sherif, chairman and chief executive of Medidata Solutions Inc. has stated that: “Philosophically, the market is there for both retail and institutional investors. It pays to have a diverse share base” (WSJ).
Change Over Time
The popularity of stock splits has decreased over time with the exception of Apple, as previously mentioned. According to S&P Dow Jones Indices, during the 1990s an average of 64 companies from the S&P 500 split their stocks each year. In contrast, between 2008 and 2013, on average only 12 S&P 500 companies split their stock each year (WSJ). While there are several reasons stock splits have decreased, one main reason is technological advancements and improvements in the financial services industry. Companies such as Schwab, Fidelity, and Robinhood now allow investors to purchase fractional shares of stock. Because investors can now purchase a fraction of a share, companies with elevated stock prices remain accessible to retail investors even without a split (TheStreet). It’s likely that we’ll see fewer stock splits as financial technology and investment apps make it easier to buy and sell stock with little to no commissions and a lot of flexibility.
How to Explain a Stock Split to Employees
When explaining a stock split, your employees need to understand three basic things:
- Stock splits are NOT bad news.
- The total value of what the employee holds is unchanged.
- A lower price per share encourages new investors, driving up the stock price.
Stock splits are NOT bad news
To employees inexperienced with the terminology associated with financial markets, the word “split” may have a negative connotation. But in this setting, a stock split can be good for a company and its long-term goals. Help your employees understand that successful companies such as Tesla and Apple have executed stock splits several times, and the split shares have continued to increase in value. For example, a few days prior to Tesla’s most recent stock split on August 31, 2020, its market cap was $377 billion. A little over a year after the split, its market cap is almost $1.2 trillion.
The total value of what the employee holds is unchanged
This key concept is best explained simply. Imagine cutting a pie in halves, fourths, or eighths. It doesn’t mean you have less of the pie, it just means you have the same pie cut into smaller pieces. When all the pieces are put together, the total pie is still there with its same value.
A lower price per share encourages new investors which can increase the stock price
Your shareholders will generally want the stock price to increase from its initial basis. Once a stock price gets too high from its initial starting point, a split can encourage new investors to buy in at a lower price per share. This process encourages continual growth and is a healthy sign for a business. In addition, with a larger number of investors in the shareholder base, the market for the shares is more liquid, making it easier for employees to exchange their shares for cash. Help your employees know that a stock split can be celebrated as a significant milestone in your company’s journey.
A stock split may initially be received poorly among those without a finance background. Helping your employees understand what a stock split is and how they can benefit is an important task for you and your team to consider. By explaining that stock splits can help the organization continue to grow and that the value of an employee’s holding is unchanged, you can ensure that your employees are taken care of as you navigate this important move.