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  • The Dynamics of Shareholder Capital – Part I

The Dynamics of Shareholder Capital – Part I

Do Stock Splits Matter?

For the last six months, there has been one stock that has dominated the conversation – NVIDIA Corporation (NASDAQ: NVDA)

This is justified as NVDA has seen growth in revenues and profitability at an almost unprecedented pace and scale.

This has also resulted in an incredible performance for the stock. We are sure you know what the stock had done, but just in case…

In the last year, the stock has been up almost +200%.

It also dominates the conversation about the markets in an unprecedented way.

It is not unusual for the stock to make up 10% or more of the TOTAL dollar volume traded in S&P 500 stocks. Some days, it has been as much as 25%!

Again, there have been very few (if any) situations like this…

The company announced a "10-for-1" stock split with their recent blow-out earnings.

Many of you may be familiar with this concept, but let’s go through it for those unfamiliar.

Right now (according to Bloomberg), there are 2.489 billion shares of NVDA stock outstanding. This should include the appropriate adjustments to give us an actual number.

Each share trades at roughly $1100 – giving the company a market capitalization of almost $2.7 trillion.

With the "10-for-1" stock split, what is going to happen is that for every outstanding share, they will issue 9 more additional shares.

If you own 100 shares today (a $110k position), then you would own 1000 shares after the split. The share price, however, will also be adjusted, and instead of $1100 per share, it will be reduced to $110 per share.

Economically, nothing will have changed. The value of your stake in NVDA will remain precisely the same.

You simply will own more shares at a lower price.

The stock market took this as good news. If no economic value is created, why would there be a positive response?

A few years ago, there was an argument to be made about the affordability of buying stocks with very high share prices. 

Way back in the day, you could only buy in 100 shares lots. That would mean you would have to have a minimum of $100k to be able to buy NVDA shares. That would eliminate a lot of potential retail shareholders.

Over the years, though, buying smaller lots of stock became possible—as little as even ONE share.

Most recently, "fractional" shares were also invented. Fractional shares are new, but a shareholder could participate in NVDA stock with as little as $100.

With reductions in transaction costs to almost $0, there are now few barriers for retail investors to buy the stock.

Does a lower stock price make you more likely to be involved in a stock or its options?

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Then why do it? What value does it add?

There are a couple of technical areas where it could create additional demand and liquidity for the stock.

For the options markets, a lower stock price means that each contract is cheaper. It also means that you would need to maintain less money in your brokerage account to be able to trade the options.

This should increase the demand and liquidity in the options. Does this create more demand for the shares?

Not necessarily, and it may increase volatility as if NVDA needed that!

Another potential positive could be an inclusion in the Dow Jones Industrial Average.

That index is calculated on a “price-weighted” basis. This means that they take the 30 components and take one share of each to calculate the index.

Currently, the index's most significant component is UnitedHealth Group (NYSE: UNH), with an 8.5% weighting. This is because it has a $495 share price.

UNH isn't a small company with a $450 billion market capitalization.

However, Walmart Inc. (NYSE: WMT) only has a 1.12% weighting with its $65 stock price and a $530 billion market capitalization.

In our view, the Dow Jones Industrial Average doesn’t make much sense and is not particularly useful.

Could a $110 stock price versus $1100 make it more likely that NVDA gets included in this index? Maybe.

Would that create more demand for the stock? Not very much in our view.

Honestly - we don't think very much, but it is a positive sentiment for big companies.

What do you think of the value of stock splits? Share your thoughts in the comments section online or at [email protected]

We subscribe to a research service called Bespoke Investment Group. They do some great analysis, and you should check them out!

They recently published some data on stock splits by S&P 500 companies. The tables are below…

You can see that stock splits are now relatively uncommon in the S&P 500 compared to twenty years ago. We think company boards now understand that they don't add much value.

Looking at the performance of the split stocks does share some insight.

Usually, an S&P 500 stock that splits has gone up a lot! +74% in one year is crazy good performance, and very few companies ever see that kind of one-year return…

After the split, the stocks don’t seem to do all that much. That shouldn’t be surprising.

Stocks that go up +74% in one year usually need a breather.

From there, though, they exhibit strong performance—+19 % in the next year, or roughly double the performance of the S&P 500.

This is likely because whatever combination of positive dynamics that led the stock to be +74% in the previous year persisted in the following year. Strength begets strength.

We don't think that stock splits matter for a company's economic value. They may not matter much for the stock, but they are not a negative.

Fresh off narrowly avoiding a long stint in Moldovan jail, the legend Whitney Tilson caught up with our founder – Enrique Abeyta – on the inaugural episode of the HX Podcast.

We discussed our respective 2024 MARKET OUTLOOKS along with some CORE VALUES that investors should think about in their portfolios. We also discuss a special offer for Empire Financial subscribers. Check it out!

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