Could stock splits send the stock market to a new high?

Over the past 15 months, investors have witnessed history on Wall Street. They sailed through the fastest 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 benefited from the strongest rebound recovery since an all-time bearish low. At one point, the S&P 500 rallied 88% from its March 23, 2020 low.

However, the stock market stands as a crossroads. On the one hand, history tells us that if we buy high quality stocks and hold them for the long term, the trend is likely to be up. On the flip side, history has shown that rebounds from bearish bottoms are never so perfect. For starters, S&P 500 valuations are stretched to levels not seen in about two decades.

This begs the question: if the stock market is to reach new highs from here, what will be the catalyst? Maybe the answer is stock splitting.

Image source: Getty Images.

Stock splits: the most vaunted non-events

Simply put, a stock split describes an event whereby the board of directors of a company chooses to increase or decrease the number of outstanding shares of a company to change the price of its shares.

For example, a 2-to-1 forward split would involve the issuance of one new share for each share currently held, while halving the price of the existing share. The market value of the company has not changed, but there are now reportedly twice as many shares outstanding with a share price 50% lower than it was before. If Company XYZ had 100 shares outstanding and a price of $ 10 (i.e. a market cap of $ 1,000), a 2-for-1 stock split would mean it now has 200 shares outstanding at a price of $ 5 (still a market cap of $ 1,000).

It should be noted that reverse stock splits also exist. Companies with low stock prices can adopt reverse splits to reduce the number of shares outstanding and increase their stock price. But for the purposes of this discussion – that is, sending the market to a new high – I’ll just focus on futures stock splits.

Silver dice that say buy and sell rolled on a digital screen displaying a stock chart and volume information.

Image source: Getty Images.

The psychology behind stock splits

While stock splits have no effect on a company’s underlying transactions or market capitalization, there are some psychological factors that come with it.

For example, a popular stock that increases its number of stocks to reduce its price is likely to be viewed as more affordable (on a nominal basis) by retail investors. Last week the chipmaker and graphics card giant NVIDIA (NASDAQ: NVDA) announced that it will divide its stock 4 to 1. In doing so, NVIDIA will reduce its stock price from about $ 600 to $ 150. If investors have the option of buying fractional shares through their brokerage, that’s not a big deal. But for retail investors who cannot buy fractional shares, their initial entry amount to buy into NVIDIA is going to be lowered from $ 600 to around $ 150.

Stock splits almost always contribute to liquidity. Having more stocks traded daily can help narrow the gap between a stock’s supply (the price at which investors want to buy) and demand (the price at which investors want to sell). This can make buyers and sellers feel like they’ve received the best possible price for their transaction.

But perhaps more importantly, stock splits are seen as a sign of operational success. In other words, a company wouldn’t divide its stock price if it wasn’t seen as high – and it wouldn’t be high if the company wasn’t doing something right in the eyes of investors.

Take a look at what happened to the tech stock Apple (NASDAQ: AAPL) and manufacturer of electric vehicles You’re here (NASDAQ: TSLA) after announcing their intention to separate last year. On July 31, Apple unveiled a 4-to-1 split, with Tesla announcing a 5-to-1 split on August 11. In the 31 calendar days before it took effect, the world’s largest company (Apple) saw its shares gain 30%, while Tesla hit an even more impressive 61% in the 20 calendar days between its announcement and the effective date of the split.

A father carrying an Amazon package under his arm while his daughter holds an open door.

Image source: Amazon.

Could a trio of stock splits propel the S&P 500 to new heights?

Given the generally positive track record surrounding stock splits, a trio of very large and very popular stocks may hold the key to propelling the larger market higher.

The first is the e-commerce giant (NASDAQ: AMZN), which has split its stock three times before, but hasn’t done so since September 1999. Investors with access to fractional investing have the option to put $ 10 into Amazon as often as they like. But if your broker does not allow the purchase of fractional shares, you will currently need to save around $ 3,200 to buy a single share. If Amazon were to split, it would make its stock accessible to those small retail investors and likely start a fire below the S&P 500 in the process.

Another FAANG stock that could propel markets higher with a split is Alphabet (NASDAQ: GOOGL)(NASDAQ: GOOG), the parent company of the globally dominant internet search engine Google and the streaming platform YouTube. At around $ 2,345 per share, Alphabet priced some retail investors without access to fractional shares out of the market. Like Amazon, Alphabet’s core business is well known and a split would undoubtedly create a lot of buzz.

The third stock that could help push the broader market higher with a stock split is (again) Tesla. Just when Tesla’s stock split went into effect last year, its 12-month return was close to 1000%! Its share price doubled again before falling back a bit. Still, the top producer of electric vehicles in the United States is still trading at $ 581 this past weekend, which may be seen as restrictive for some investors.

Keep in mind, however, that the euphoria of the stock split tends to be short-lived. While one or more of these popular companies could set off a market rally that propels the widely followed S&P 500t to new highs, there is no substitute for operational 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 premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

About Jason Norton

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