The RSMR Weekly Broadcast - Tricks of the trade: split or reverse split

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Apple recently crossed the $2 trillion market capitalisation mark, becoming only the second company in history ever to do so. From a garage in Los Altos, California to the most profitable company in the world with its devices, services and ethos interwoven into much of modern daily life, Apple became worth more than the combined FTSE 100.

In July, the value of Tesla hit an all-time high. CEO Elon Musk is now the seventh-richest person in the world, surpassing legendary investor Warren Buffett.

After a company goes public and its shares start trading on a stock exchange, its share price is determined by the supply and demand for its shares in the market. If there’s a high demand due to favourable factors, the price will increase. Apple and Tesla stock has soared to new highs recently and before the market opened on the 31^st August, Apple and Tesla split their stocks 4 for 1 and 5 for 1 respectively.

There’s no denying that tech companies such as Apple, Microsoft, Amazon, Alphabet and Facebook have had a phenomenal year. The devices and services they provide, combined with a low interest rate environment, has caused their share prices to surge. If the share price goes up, there’s likely to be a smaller pool of potential investors as fewer people will be able to afford to buy one share. Fractional shares on trading apps such as Robin Hood help to broaden the pool but companies do have the option of a stock split to make the shares more palatable and to achieve a higher rate of liquidity. Stock splits reduce the price of their shares, making them more attractive to new investors. Since the split, Tesla shareholders now have  five shares for every one share they previously owned and Apple shareholders will now have  four for every one share they previously owned.

Whether you have one share of Tesla at $2,000 or five shares at $400, the total value of your investment is exactly the same, but psychologically speaking, it's a lot easier for an investor to come to terms with buying additional shares of Tesla stock at $400 than it is to buy a single share of stock at $2,000. It's also easier for an investor to raise $400 in spare cash than it is to build up $2,000 in order to buy a share.

At the opposite end of the scale, shares can be consolidated. A share consolidation (or reverse stock split) occurs when a company decreases the number of shares it has on issue. This causes the share price to increase proportionally, so that the value of each shareholders' holding remains unchanged relative to the market capitalisation of the company. One motivation for doing this is that stock exchanges have minimum share prices, if a stock price falls below the minimum price, the shares can be delisted. Delisting raises the cost of capital to a firm by making it harder to raise equity capital. Another motivation behind the decision to consolidate is the ‘respectability’ factor; a low share price is considered a sign of weakness by investors who may then be put off and avoid the shares. From a marketing perspective they are looking to get some credibility back in the share price.

Companies wanting to raise capital will carry out multiple placements to increase the number of shares and if the market cap doesn’t go up, the share price will go down. They follow this by a share consolidation, the number of shares reduce, the market cap stays the same, the share price goes up and then the cycle starts all over again but not all companies go in for these tactics, for example one share with Berkshire Hathaway is currently worth around $330,000.

Is a stock split a good or a bad thing? Splits can be a bullish sign with valuations getting so high that the stock is out of reach for smaller investors trying to stay diversified. Investors who own a stock that splits may not make a lot of money immediately, but they shouldn't sell the stock since the split is likely a positive sign. A stock split has absolutely no bearing on a company's market cap or fundamentals, it's entirely cosmetic and designed to raise or lower a company's share price but Apple and Tesla are setting their own pace.

QUIZ QUESTION: What did the first Apple logo feature?

LAST WEEK'S ANSWER: There are more than 80,000 cyber-attacks in the US every day!