Split, Cut, Slice
Thanks Aunt Amiee for the topic!
Why do the price fluctuate so widely when values can’t possibly? I will tell you the answer I have come up with: The answer is I don’t know and I don’t care. We could waste a lot of time about psychology but it always happens and it continues to happen - Joel Greenblatt
Split $1 into 4 quarters. Cut a sandwich in half. Slice a pizza into 8 pieces.
The underlying physiology does not change. Your wealth did not change. Your sandwich has the same calories. Your pizza has the same amount of cheese. Nobody has gained, and nobody has lost. Split, cut, and slice all you want. You still end up with the same result.
Forward stock splits are similar. Companies take their existing shares, and split them. Sometimes in half. Sometimes into 20s.
Today you own 100 shares at $10.
The company splits.
Now you own 200 shares at $5.
Either way- the underlying value of the business should not change.
The sandwich has the same calorie count. The pizza is as cheesy as ever. Your brokerage account still says $1,000. Just because you increased the amount of pieces does not mean that the whole has changed.
Right?
Academics would say otherwise. After decades of research, academics have concluded:
Stocks that split outperform by ~2% in the short term
Nobody can agree why
Satisfying, right?
As my Aunt alluded to in her request- several of the largest companies have recently announced stock splits. Amazon. Google. Tesla. Why?
C-suite executives often suggest that the reason for splitting is to lower their stock prices. This allows smaller investors to buy more shares. The argument is that these investors cannot participate in owning Berkshire Hathaway ($400,000+), NVR ($4,000+), or Autozone ($2,000+).
This tells us why managers split their stock. It does not explain the relative outperformance.
Instead of re-hashing a dozen academic papers (I fell asleep writing that)- a 2007 paper summarizes some of the theories. If you're into that academic-type stuff...
All we know is that on average, splits outperform. We don’t know why. All going theories have mixed results and have either been refuted or outright disproven.
I will tell you the answer I have come up with: The answer is I don’t know and I don’t care. We could waste a lot of time about psychology but it always happens and it continues to happen
Joel Greenblatt makes it clear that sometimes you don’t need to know the underlying reason. Sometimes knowing that something happens without understanding why is necessary to make money. Fair enough, Joel.
On the other hand, if post-split companies start to underperform on average over the next 20 years- understanding the underlying reason suddenly becomes important.
We blindly trust and use without knowing much about the underlying all the time. Food. Your computer. Substack posts.
Is it easy to blindly trust? Yes. Is it smart? Maybe. Should you do this with stock splits? I'm not. Give me the underlying causes and then we will talk. Until then, see you all next time.