Companies that have completed or announced stock splits in recent times have soared. Stock splits reduce the price of individual stock prices without changing the overall market value of a company. The trend was not limited to one sector, but extended from consumer goods to restaurant operators and technology.
Walmart launched its stock split earlier this year, while chip designer Nvidia (NASDAQ: NVDA) completed a few weeks ago. Chipotle Mexican Grill will run one next week, and a semiconductor company Broadcom will launch its split next month.
All of these stocks are up double digits this year, with the exception of Nvidia, which is up triple digits. Clearly, investors are excited about the future of these companies, but does that mean you should rush and buy Nvidia, as well as companies that could announce or have announced a split?
Why do companies launch stock splits?
First, let’s talk about stock splits in general, and what they mean for a company. Each of the companies I mentioned above announced a forward stock split, offering additional shares to current shareholders. The goal is to lower the price per share, making the stock more accessible to a wider range of investors.
If you owned the shares before the split, the value of your holdings will not change after it occurs, but the number of shares you own will change depending on the ratio of the split. For example, in a 10-to-1 stock split, the company issues you nine additional shares for every share you own. Nvidia and Broadcom each announced a 10-to-1 ratio, with the idea of ​​reducing the price of shares that were above $1,000 to less than $200.
Nvidia’s stock is now trading for about $130 per share, and given Broadcom’s current price of $1,807, the company’s stock should trade for about $180 when the split is completed. This price may change slightly depending on the stock’s movement prior to the stock split.
How to explain the profits
Although companies that have announced splits are showing higher growth this year, stock splits themselves are not a catalyst for stock price movements. That’s because they are mechanical operations and don’t change anything fundamental about a business. How can we explain the stock split stocks’ recent gains?
It’s important to remember that companies typically plan a stock split when all goes well. The stock price has risen, and that’s mostly due to earnings growth over time. These companies are optimistic that after lowering the high-flying share price, the stock will once again enter a new phase of growth, due to concrete reasons such as good profit prospects and demand for their products or services.
The top performance we’ve seen in stock splits isn’t related to the split itself, but to continued optimism about the companies’ track records and future prospects.
Stocks to watch
What we can conclude is that stock splits alert us to companies that have been successful over time, and this means they are the ones we should keep an eye on and consider. But this doesn’t mean we should automatically buy every stock split player.
It’s important to consider each company’s journey to date, the market environment and its long-term prospects. Past successes do not automatically equate to future successes, no matter how optimistic the company in question is. Therefore, you should consider each stock split on a case-by-case basis.
Other things to consider are your familiarity with the industry the company operates in and your investment style. For example, if you have no knowledge of the chip industry and are a very cautious investor, Nvidia may not be the best choice for you. Understanding a company and how it fits into its sector is essential as this will help you make the best investment moves over time.
Yes, right now, stock split stocks are on fire and capturing investors’ attention. But if you want to make long-term profits – and these generally offer you the best returns – it’s crucial to keep a cool head and pick a stock for its earnings strength and potential years down the road – not because it merely announced a stock split.
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Adria Cimino has no positions in the stocks mentioned. The Motley Fool holds positions in and recommends Chipotle Mexican Grill, Nvidia, and Walmart. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
Nvidia and other split stocks are on fire. Time to buy? was originally published by The Motley Fool
