What is a stock split and how does it impact prices?

When Tesla and Apple split their stocks in August 2020, newly minted traders were left with questions. What does this mean for stock prices? And should I buy more or sell?

What is a stock split?

A stock split is where one stock is divided into several stocks along with its share price. As Tesla had a 5-for-1 stock split, one stock became five at one-fifth of the price, while Apple split its stock 4-four-1, with one stock divided into four. It doesn't change the value of the stock or the company, it just means there are more shares circulating the market at a lower purchase price.

Despite this fact, Tesla's share price rallied as high as 12% in the first day of post-split trading and Apple stocks jumped as much as 5%. While some might see it as irrational optimism, historical data collected by online broker eToro shows that such a response does make sense.

How do stocks perform after a stock split?

According to eToro data from the 10 biggest global brands that have performed a stock split over the last 60 years, prices rise 33% on average in the 12 months following. Amazon, which has performed 3 stock splits, saw prices jump an average of 209% one year later, while Microsoft rose 47% and Toyota increased by 25%.

Apple has undergone four previous stock splits in its 40-year history on the stock market, with prices rising 10% on average in a year. Following its 2005 stock split, Apple shares jumped 58%, and then 36% after its 2014 split.

Of course it's tricky to measure how much of an impact the stock split itself had on prices compared to other factors. When Apple split stocks in 2000, its share price was 60% down 12 months later thanks to the dot-com crash. And because companies usually split stocks when they're performing well, there may be a whole host of reasons why prices continue to go up in the near future.

Just two of the 10 companies analysed, Alphabet (Google) and Samsung, saw prices drop on average. Alphabet, which carried out a stock split in 2014, saw its stock price fall 6% according to eToro, though this instance was a little unusual.

Google's stock split in 2014 created two new classes of shares – Class A shares (GOOGL), which offer shareholder voting rights, and Class C shares (GOOG), which offer no voting rights.

Why do stocks rally after a split?

When companies split stock, they're increasing the number of their shares in the market and reducing prices. More stock in the market means more liquidity, which means stocks can be bought and sold quickly and small-scale orders wont substantially impact share prices, hence reducing volatility.

Lower stock prices also make the stock more affordable to the masses and it signals that the stock has been performing well. All of these factors can make the stock more appealing to investors.

As share trading platforms become increasingly popular among younger investors, including in emerging economies such as China, India and South America, lower stock prices may well become even more important.

What about fractional shares?

Anyone using an app that offers fractional share trading, such as eToro or Robinhood, might be wondering what the big deal is.

Fractional share trading is where you can invest in slices of shares rather than whole shares. Rather than buying one Tesla stock for $450, you could own one-tenth of a stock for $45, or 1.1 shares for $495.

Stock splits make little difference to fractional share traders in terms of affordability. If you owned a fraction of a Tesla or Apple stock prior to the split, you may find yourself owning 1 or 2 whole stocks.

However, fractional trading apps are also still relatively few and many countries don't offer the option. In Australia for example, it's not yet possible to invest in fractions of ASX stocks. However you can trade fractions of US stocks on certain apps.

At the end of the day, no-one can say for certain where Apple and Tesla will be in 12 months, though the reaction so far has certainly been a bullish one.