While the 9% Wednesday gain that Tesla is seeing on news that it plans a 5-for-1 split feels very questionable for the simple reason that the split does nothing to increase a Tesla investor’s ownership stake in the company, there is a stronger argument for carrying out such a move at a time when zero-commission trades have become the norm at online brokerages.
Tesla’s current $1,516 stock price translates into roughly a $303 post-split price. Prior to zero-commission trades, someone looking to own just one share of a stock at a more affordable $303 might have to pay (just like an investor making a much larger purchase) $15 to $20 in commissions, between the time that he or she bought the share and sold it. In other words, the stock would have to go up about 5% to 7% just to recover the cost of the commissions.
Today, with brokerages such as Schwab, Etrade, Fidelity and Robinhood not charging commissions on regular U.S. equity trades, an investor making such a purchase isn’t starting out 5% to 7% in the hole. This naturally makes U.S. equity investors on a budget -- a demographic whose numbers appear to have soared this year, judging by new brokerage account openings -- more willing to pull the trigger on trades. And it gives companies such as Tesla a greater incentive to make their shares easier for budget-constrained investors to purchase.
In addition, stock splits provide greater flexibility to investors who may have previously been able to buy only a small number of shares of a particular company. For example, an investor with $2,500 to invest in Tesla would be able to deploy $2,400 to buy eight post-split shares, as opposed to deploying just $1,500 to buy one pre-split share. Also, he or she would have the option to sell half of those shares at a later date while holding onto the other half.
Fractional share purchases, which are now supported by several online brokers, do in theory give investors with limited resources such benefits in the absence of a stock split. However, there are still some major brokerages that don’t support them (for example, Etrade, as well as many international brokerages), and some of the ones that do, such as Schwab and Robinhood, don’t support limit orders for fractional trades.
Meanwhile, though it may not be completely rational, it’s hard to ignore the fact that stock split announcements are often leading the shares of the companies announcing them to jump.
And though a stock with a high dollar value can trade at low earnings/cash flow multiples and vice versa, many retail investors are nonetheless still prone to judging how “expensive” a stock is based on its dollar value. One only has to look at how (per website Robintrack) many of the most widely-owned stocks among Robinhood investors have sub-$10 prices.
All of this can’t be lost on companies with high-dollar-value stock prices as they mull whether or not to split their shares.
And as a result, it wouldn’t be surprising to see other tech companies with such stock prices, such as Amazon.com (AMZN) - Get Report, Alphabet (GOOG) - Get Report, Shopify (SHOP) - Get Report and Netflix (NFLX) - Get Report, make split announcements of their own in time.