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GameStop Stock: How a Split Could Trigger a Rally

GameStop recently announced a plan to split its stock. Here's how that could trigger a rally for GME.

Last week, GameStop  (GME) - Get Free Report announced that it plans to implement a stock split, pending shareholder approval. The company hopes that the split will give GME shares greater liquidity.

Although a stock split should have no effect on the company's valuation — you can think of it like cutting a pizza into smaller slices — practice has shown it to be a catalyst for short-term gains.

Here's why a stock split could trigger gains for GameStop shareholders.

Figure 1: GameStop Stock: How a Split Could Trigger a Rally

Figure 1: GameStop Stock: How a Split Could Trigger a Rally

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GameStop Seeking Stock Split Approval

On March 31, GameStop announced that it plans to ask its shareholders during its annual meeting to increase the common stock from 300,000,000 to 1,000,000,000 to partly implement a stock split in the form of a dividend.

GameStop's goal is to increase GME's liquidity to help meet the company's future needs. The split ratio has not yet been announced.

Theoretically, a stock split doesn't add any value to a company. And retail investors can buy cheaper, fractional shares of expensive stocks through most brokerages today. So a stock's high price really shouldn't be a barrier to entry.

Perhaps the most relevant reason for the split lies in the options market. Considering that a standard call or put contract is equivalent to 100 shares of an asset, in GameStop's case, one share contract has a high value of almost $16,595.

Thus, with the split, there could possibly be more entrants trading GameStop options. For example, if a 3:1 split occurs, each options contract would represent an asset exposure of only $5,500.

But maybe the real benefit of the stock split is psychological. Historically, stock splits have impacted shareholder sentiment and have fostered short-term rallies — as seen in the recent cases of giant tech companies like Tesla  (TSLA) - Get Free Report and Amazon  (AMZN) - Get Free Report this year, and Nvidia  (NVDA) - Get Free Report and Apple  (AAPL) - Get Free Report in 2021 and 2020.

Because the value of the company does not change with a stock split, these short-term rallies can be blamed on the market's irrationality. But at the end of the day, share prices are determined by supply and demand. And it is precisely on this basis that GameStop shares have been performing so strongly since January 2021.

GME's Stock Dividend

There's an interesting detail in GameStop's stock-split proposal. The company has opted for a stock split in share dividend format, which implies a slightly different mechanism than a regular split.

GameStop will give each shareholder one more share as dividend. So besides the stock split, this extra dividend share for each shareholder will theoretically still double the float.

But what difference does this make to GameStop stock? It turns out that short sellers who are betting against the stock will need to buy an additional share to distribute to the holders of shares that they have sold short.

Short interest in GameStop recently increased in March. In mid-February, 11.94 million shares were being shorted. In mid-March, the number rose to 12.35 million, which implies that more than 26.6% of the total float is being shorted.

Even though the historic short-term optimism that splits bring to a stock is a warning factor for short sellers, in the specific case of GameStop's stock dividends, shorts may be in even more imminent danger.

The Next Steps for GME

March was a very positive month for GameStop shares. However, the current macro picture is less uncertain.

Since the Fed announced the interest rate hike in mid-March, the S&P 500 and the Nasdaq have been on a rally of over 8% and 15%. respectively. And GameStop shares have been reacting similarly to broader market themes, up more than 40% in March alone.

Apart from the macroeconomic influences, GameStop Chairman Ryan Cohen's announcement he has acquired another 100,000 shares has helped the recent strong performance. Also, GameStop's new projects in the NFT marketplace and crypto has helped keep GME's popularity at a strong high. GME has far outperformed other popular stocks discussed regularly in subreddits such as r/wallstreetbets.

GameStop has yet to announce the dates of its annual shareholder meeting — which historically takes place in June — and the stock split needs to be voted on before it can be executed. But this will likely be a relevant share-price mover.

(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting Wall Street Memes)