Amazon Announces 20-for-1 Stock Split

What does this mean, though?

What Happens When a Stock Splits? 

Simply put, a stock split is exactly what it sounds like. One share gets divided, or split, into multiple shares. Don’t worry, though. The value of your holdings is the same, just in smaller chunks. 

Think about it like a dark chocolate bar. Your one big dark chocolate bar is broken down into multiple bite-size pieces. You still have the same amount of chocolate, just in smaller pieces.

Similarly, in a stock split, it is very important to remember that the price of the share also is reduced. For example, if a company board announces a two-for-one split, then you get one extra share for each share you own. But the share price will be halved. In this example of a two-for-one split, if you had one share of Company X at $10 per share, you now have two shares of Company X at $5 per share.

This does not mean that the stock has become cheaper. The fundamentals of the company and the stock price have not changed. Sticking with the dark chocolate bar analogy, after breaking the bark into smaller bits, you have smaller bits of dark chocolate, not more chocolate overall.

But Why Does a Company Split Its Stock?

Why do companies announce stock splits?

Stock splits are a way for companies to increase the overall liquidity.

Liquidity means the ease with which investors can buy or sell shares on a stock exchange. The smaller the dollar amount of each share, the smaller number of dollars needed by even the smallest investor to buy or sell that stock.

In most cases, stock splits are undertaken by companies when the share price has gone up significantly, particularly in relation to a company’s stock-market peers. If the share price becomes more affordable for smaller investors, it can reasonably be assumed that more investors will participate, and so the overall liquidity of the stock would increase as well.

But remember this with stock splits: Though the number of outstanding shares changes, and though the price of each share changes, the overall market capitalization of the company stays the same. The value of the company doesn’t increase when a split occurs, therefore the value of your stocks, your shares, doesn’t change, either.

Take Alphabet for example. It closed Tuesday, Feb 1^st at $2572.88. May investors (myself included) would not be able to invest in Alphabet, because I do not have $2500-odd to invest in one share of one company. Now if the stock split were to happen as of Tuesday’s close, the cost of each share would go from $2572.88 to $128.64, and each existing holder would get 19 additional shares for every share they own. A stock price of $128-odd would be much more manageable, both for me, and for many others. 

This is especially true now with more and more investors having access to low-cost trading platforms. Buying and selling stocks is now easier than ever, and for many investors, these recent splits might be an entry point for companies they have long admired.

All of this being said, these recent high-profile splits seem superfluous given that most brokerage platforms now enable trading in fractional shares. Perhaps the psychology of owning at least one whole share is at play in the companies’ decisions.

But additional participation by smaller investors could also lead to the price increasing, which we saw in the prices of both Apple and Tesla immediately after the stock split announcement.

“When we strictly observe the value of an investment immediately after a stock split, there really isn’t a discernable pattern in the change in wealth. What is noticeable is the trading volume of the stock which might be attributed to news flow. All this said, for long term investors in a stock, a stock split (or reverse split) really doesn’t affect the fundamental value of the company or the wealth in your pocket,” points out Morningstar Canada’s Director of Investment Research Ian Tam.

Does the Company Change?

Not at all. Stock splits do not alter the fundamentals of the company in any way, apart from the short-term price increases we described earlier. There’s no harm done in this regard if the stock doesn’t split either.

In fact, this is not the first time Amazon has split its stock. The company did this three times in the 1990s. A 2-for-1 split twice (in 1998 and 1999) and a 3-for-1 split in 1999. Yes, in 1999, Amazon announced two separate stock splits. 

The Amazon stock popped after the announcement, but despite this, Morningstar analyst Dan Romanoff views the shares as undervalued. “We think the highlight was Amazon's plan to raise prices in the U.S. on Prime to $139 from $119, beginning on Feb. 18 for new members, underscoring Amazon's pricing power and highlighting Prime as a revenue driver. Meanwhile, Amazon will continue to invest heavily in Amazon Web Services, or AWS, fulfilment capacity and delivery, although we see these beginning to ease in the second half of 2022. Overall, we do not see issues with the long-term story as Amazon remains well positioned to prosper from the secular shift toward e-commerce and the public cloud over the next decade,” he said.

He thinks the company is solid. It dominates its served markets, notably for e-commerce and cloud services. It benefits from numerous competitive advantages and has emerged as the clear e-commerce leader given its size and scale, which yield an unmatched selection of low-priced goods for consumers. “The secular drift toward e-commerce continues unabated with the company continuing to grind out market share gains despite its size. Prime ties Amazon’s e-commerce efforts together and provides a steady stream of high margin recurring revenue from customers who purchase more frequently from Amazon’s properties. In return, consumers get one-day shipping on millions of items, exclusive video content, and other services, which result in a powerful virtuous circle where customers and sellers attract one another. The Kindle and other devices further bolster the ecosystem by helping attract new customers, while making the value proposition irresistible in retaining existing customers. Through Amazon Web Services (AWS), Amazon is also a clear leader in public cloud services,” Romanoff says.

Morningstar assigns a wide-moat rating to Amazon.com based on network effects, cost advantages, intangible assets, and switching costs. “Amazon has been disrupting the traditional retail industry for more than two decades now, while also emerging as the leading infrastructure-as-a-service, or IaaS, provider via Amazon Web Services, or AWS. This disruption has been embraced by consumers and has driven change across the entire industry as traditional retailers have invested heavily in technology in order to keep pace. COVID-19 has accelerated change, and given its technological prowess, massive scale, and relationship with consumers, we think Amazon has widened its lead, which we believe will result in economic returns well in excess of its cost of capital for years to come,” Romanoff says.

What is a Reverse Stock Split? 

The opposite of a stock split, which is technically called a forward stock split, is a reverse stock split.

In the case of reverse stock splits, the company divides the number of shares that investors own, rather than multiplying them. As a result, the price of the shares increases.

For instance, if you own 10 shares of Company X at $10 per share, and the company announces a one-for-two reverse stock split, you end up owning five shares of Company X at $20 per share. Usually, reverse stock splits are announced by companies that have low share prices and want to increase them – oftentimes to avoid being delisted. 

Is a Stock Split Good? 

You may think that reverse stock splits are bad news for the company, but this is not always the case. One of the most famous examples of reverse stock splits is Citigroup (C). Its share price declined to under $10 during the 2008 financial crisis and stayed there, so the board decided in 2011 Citigroup to do a reverse split of one-for-ten. The split took the price from US$ 4.50 per share to US$ 45 per share. The company—and the stock—survived and is now trading at around US$ 52 per share.

See, just math!