Broker Check

What is Amazon Thinking?

March 18, 2022
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I have a confession to make. I love the feeling of $100 bills in my wallet. It’s purely psychological, and I can’t explain why, but it just does it for me. I’ll take one $100 bill any day over five $20s, but Benjamins are impractical because most merchants will not accept them, and they don’t work well for small purchases.

High stock prices can cause similar challenges for companies and investors. For example, Berkshire Hathaway (ticker: BRK.A) is over $504,000/share and averaged just over 300 shares traded daily prior to 20221. This makes transacting more difficult and expensive when compared to a stock with higher volume.

Furthermore, a mere 5% allocation to BRK.A requires a portfolio size of over $10 million ($504,000 ¸ 5% = $10,080,000). If an investor wants to buy exactly $150,000, they are out of luck unless the broker offers “fractional shares,” which is the ability to buy part of a share of stock.

Management can also face challenges paying its employees in stock. For example, if an employee earned a $2,500 bonus to be paid in stock, but the stock is $3,000/share, they may have a problem.

Corporate boardrooms occasionally split their stock to alleviate these issues. A stock split is a corporate action that increases the number of shares, which in turn reduces its price. The stock's market capitalization, or the total value of the equity, remains the same. It’s no different than swapping a $100 bill for five $20 bills at the bank. The number of bills in a wallet rises but the total value of cash is unchanged.

For example, a 2-for-1 stock split adds an additional share for each share held, but the value of each share is cut in half. If a shareholder owns 50 shares of a $100 stock for a total of $5,000 ($100 x 50 = $5,000), the investor will now own 100 shares of a $50 stock for the same total of $5,000 ($50 x 100 = $5,000).

Amazon did it again

Amazon recently announced that its board approved a 20-for-1 stock split. This means each shareholder will receive 19 additional shares for every share held. This is their first stock split since 1999, and although it may alleviate some of these challenges, there could be other motivations at play.

Stock splits can impact the marketability of a company’s stock in several ways. First, lowering the share price could increase demand from individual investors who have wanted to own Amazon but couldn't afford to pay $3,000+ for a single share. It may also attract those investors who could have owned a handful of Amazon shares but were put off by its high price. Now they can own 20 times as many shares.

Second, stock splits are usually announced after a run up in price or some other good news about the future prospects of a company, and investors tend to favor stocks with positive momentum. This interest along with the media hype that follows can add even more demand.

The third is the Dow Jones Industrial Average (Dow). This closely followed index of 30 stocks is price-weighted, where higher-priced stocks carry larger weights. Thanks to the media’s infatuation with the Dow, there is an incentive to get in the index and stay in.

To be clear, there is nothing devious going on here. Amazon handles almost half of all online sales in the U.S., so it’s not surprising they have had equal success selling their stock to investors. In fact, all large publicly traded companies have dedicated teams whose sole purpose is to market their stock to prospective investors and answer questions from existing shareholders.

Simply put, Amazon is splitting its stock for the same reason any other company splits their stock – to sell more of it.

The bottom line

Advances in trading, the elimination of transaction fees, and the rise of passive funds (investors buying more index funds and fewer individual stocks) have made stock splits a lot less common these days. There is also an administrative cost. According to the Wall Street Journal, splitting a stock could run a large company as much as $800,0002.

But Amazon’s stock popped nicely after they announced the split, and so did Google weeks ago when they announced their own stock split. The herd mentality that drives corporate America may inspire others to follow suit, and if so, we fully support this trend reversal.

Currently, over 55% of companies in the S&P 500 are trading above $100/share1. This had historically been the line in the sand where management considered a split. Some high-profile stocks like Chipotle continue to trade above $1,000/share1. Meaning, there appears to be a healthy pipeline of companies that could be next.

The bottom line is that a stock split does not increase revenues, profits, cash flow, or competitive positioning in an industry. All it really can do is impact the demand (valuation), but that’s ok. Trends that expand the shareholder base, lower transaction costs, and make diversification easier for individual investors is a win for all.







1 yCharts, As of 3/17/2022




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