What is a stock split?

Let's imagine that a stock is a pizza. This pizza is cut into pieces, but the person who bought the pizza still keeps the whole pizza. But now he can sell individual pieces and not just the whole pizza. This is basically what happens with a stock split: a share is divided by a certain ratio set by the company, for example 1:4. So everyone who previously had one share now simply gets four shares and the original price is quartered. So at first not much changes, because the value remains the same. Let's say a whole pizza costs 8€, after the split you would have 4 pieces for 2€. Straightforward, right?

Why does a company decide to carry out a share split if nothing really changes?

A stock split is mainly carried out when the shares of companies have experienced enormous price increases, leading to a high share price. The consequence of such high prices is that it becomes less and less attractive for small investors to invest in this company, because they feel uncomfortable investing a high-amount on a share (or on a pizza?). The high prices are a visual deterrent. In order not to exclude these investors, a stock split can now be carried out. This has the advantage that cheaper shares also promise a larger target group, which is important so that transactions can continue to run smoothly and it is easier to trade with the shares.

To make the whole thing more illustrative, let's look at Tesla's recent stock split. In the summer of 2019, the price of a Tesla share was still €200 (which is not that little) and experienced a significant price increase in the following months, so that a Tesla share cost a whopping €2,300 in the summer of 2020. In the course of this, Tesla decided to split its shares at a ratio of 1:5 in order to remain attractive for small investors in the future.

Perhaps you are now asking yourself why the share split is not visible in the share price? In order not to cause confusion among investors - the price would plummet drastically if the split were displayed - the share price is historically adjusted.

Ok, for small investors everything is great, and for large investors this means no disadvantage at first. But what concrete advantage do the companies experience, their capital is not increased by this, right?

In the first step, nothing changes for the company. For the pizza maker, it doesn't matter whether he sells a whole pizza for €8 or four individual slices for €2. But now that the cheaper "share pieces" are available, the attractiveness for small investors increases. Since the price of a share depends on supply and demand, and demand has increased while supply has remained the same, the stock split could also lead to the price rising again after the split. Which is not only beneficial for shareholders, but of course also for the company itself. Besides many supporters, there are also some managers and investors who reject stock splits. Why is that? It seems to be a win-win situation, doesn't it? Some investors think one should only invest for the long term (like Warren Buffet, for example) and such a stock split is practically seen as an invitation for investors to gamble. Many investors also believe that the respective shares would ultimately become even more overvalued than they already are.

Warren Buffet, best known to most as a star investor, is CEO of the investment company Berkshire Hathaway. The company does not do stock splits, partly because of the dislike of its CEO. Thus, one share (Berkshire Hathaway A share) is currently priced at a hefty €274,000, making it the most expensive share in the world. Buffet's reason for not carrying out a split is that it protects the shareholders from said "gamblers" and thus prevents extreme volatility and speculation.

Another example of a company whose shares are so expensive that small investors simply cannot afford them is Chocoladefabriken Lindt Sprüngli AG. Everyone knows the popular Lindt chocolate, which can be bought relatively cheaply in almost every supermarket. However, acquiring a share in the chocolate manufacturer is not quite that easy, because one share is currently worth €87,900. This means that the shares of Lindt & Sprüngli are not the most expensive worldwide and are still a good deal below the shares of Berkshire Hathaway, but they are the most expensive on the Swiss stock exchange. A major disadvantage of such expensive shares is that trading them is extremely difficult, they have low liquidity. It might be difficult to easily sell one or even several of these shares if hardly anyone can afford them. Lindt argues that such heavy shares lead to the desired clientele of investors. In addition, the number of shareholders is also very small, and fewer shareholders also ask fewer awkward questions.

The announcement of a stock split usually also attracts the attention of those who have not previously thought about investing in the company in question. As an investor, one should in any case not invest one's money in these shares only because of an imminent stock split, but also use other bases for decision-making. None of the reasons for a stock split is also equally a reason for investors to buy. Mostly, this measure happens because the share price has risen enormously or has been relatively constant for some time.