For the past 15 months, investors have borne witness to history on Wall Street. They navigated their way through the quickest bear market decline of at least 30% on record -- a loss of 34% for the benchmark S&P 500 (SNPINDEX:^GSPC) in 33 calendar days -- and have enjoyed the strongest bounce-back rally from a bear-market bottom of all time. At one point, the S&P 500 rallied 88% from its March 23, 2020, low.
However, the stock market finds itself as a crossroads. On one hand, history tells us that if we buy high-quality stocks and hold them for the long-term, the trend is likely going to be up. On the other hand, history has shown that rebounds from bear-market bottoms are never this flawless. To boot, S&P 500 valuations are stretched to levels not seen in about two decades.
It begs the question: If the stock market is to move to new highs from here, what's going to be the catalyst? Perhaps the answer is stock splits.
Image source: Getty Images.
Stock splits: the most highly touted non-events
In simple terms, a stock split describes an event whereby a company's board of directors chooses to increase or decrease a company's outstanding share count to alter its share price.
For example, a forward 2-for-1 split would involve issuing one new share for every share currently held, while at the same time halving the existing share price. The market value of the business hasn't changed, but there would now be twice as many outstanding share with a share price that's 50% lower than it was before. If Company XYZ had 100 shares outstanding and a $10 share price (i.e., a market cap of $1,000), a 2-for-1 stock split would mean it now has 200 shares outstanding at a $5 share price (still a $1,000 market cap).
It's worth noting that reverse stock splits also exist. Companies with low share prices can enact reverse splits to reduce their outstanding share count and pump-up their share price. But for the purpose of this discussion -- i.e., sending the market to a new high -- I'll be solely focusing on forward stock splits.
Image source: Getty Images.
The psychology behind stock splits
Even though stock splits don't have any effect on a company's underlying operations or their market caps, they nevertheless are accompanied by certain psychological factors.
For instance, a popular stock that increases its share count to reduce its share price is likely to be viewed as more affordable (on a nominal basis) by retail investors. Last week, chipmaker and graphics card behemoth NVIDIA (NASDAQ:NVDA) announced that it would be splitting its stock 4-for-1. In doing so, NVIDIA will reduce its share price from about $600 to $150. If investors have the ability to buy fractional shares through their brokerage, this isn't a big deal. But for retail investors who can't buy fractional shares, their initial entry amount to buy into NVIDIA is going to be lowered from $600 to about $150.
Stock splits almost always help with liquidity, as well. Having more shares traded on a daily basis can help to tighten up the gap between a stock's bid (the price investors want to buy at) and ask (the price investors want to sell at). This can make buyers and sellers feel like they've received the best possible price for their trade.
But perhaps most important, stock splits are viewed as a sign of operating success. In other words, a company wouldn't split its share price if it wasn't perceived to be high -- and it wouldn't be high if the company wasn't doing something right in the eyes of investors.
Just take a look at what happened to tech stock Apple (NASDAQ:AAPL) and electric-vehicle manufacturer Tesla (NASDAQ:TSLA) after announcing their intention to split last year. On July 31, Apple unveiled a 4-for-1 split, with Tesla announcing a 5-for-1 split on Aug. 11. In the 31 calendar days leading up to its split taking effect, the largest company in the world (Apple) saw its shares gain 30%, while Tesla tacked on an even more jaw-dropping 61% in the 20 calendar days between its announcement and effective split date.
Image source: Amazon.
Could a trio of stock splits power the S&P 500 to new highs?
Given the generally positive track record surrounding stock splits, a trio of very large and highly popular stocks may hold the key to propelling the broader market higher.
First up is e-commerce giant Amazon.com (NASDAQ:AMZN), which has split its stock three times previously, but hasn't done so since September 1999. Investors with access to fractional-share investing have the ability to put $10 into Amazon as often as they'd like. But if your broker doesn't allow fractional shares to be purchased, you'll currently need to save up roughly $3,200 to buy a single share. If Amazon were to split, it would makes its stock accessible to these smaller retail investors and probably light a fire under the S&P 500 in the process.
Another FAANG stock that could propel the markets higher with a split is Alphabet (NASDAQ:GOOGL)(NASDAQ:GOOG), the parent company of globally dominant internet search engine Google and streaming platform YouTube. At roughly $2,345 a share, Alphabet has priced some retail investors without access to fractional shares out of the market. Like Amazon, Alphabet's core businesses are well-known, and a split would undoubtedly create a lot of buzz.
The third stock that might be able to help push the broader market higher with a stock split is (once again) Tesla. Right around the time Tesla's stock split took effect last year, its trailing 12-month return was close to 1,000%! Its share price went on to double again before backing off a bit. Nevertheless, the leading producer of EVs in the U.S. still has a share price of $581, as of this past weekend, which may be viewed as restrictive to some investors.
Keep in mind, though, that stock split euphoria tends to be short-lived. While one or more of these popular companies could spark a stock market rally that sends the widely followed S&P 500t to new highs, there's no substitute for operating performance when it comes to dictating long-term returns.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
The Link LonkMay 25, 2021 at 05:06PM
https://www.fool.com/investing/2021/05/25/could-stock-splits-send-stock-market-to-a-new-high/
Could Stock Splits Send the Stock Market to a New High? - Motley Fool
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