Tesla Stock Split Explained
Tesla stock split explained | Will Tesla stock split again?
Hi everybody, in today’s video we are going to be looking at stock splits, what they are, how Tesla did a recent stock split and why they might do another one, and we will also look at pros and cons of stock splits.
What is stock split
First, let us understand what we actually mean by a stock split. All publicly traded companies have a set number of shares that are being traded in the market. When a company is concerned that its share price is too high or too low, it opts for stock splits to manage the prices.
A stock split is when a company issues more shares of its stock to its current shareholders without diluting the value of their stakes. A stock split increases the number of shares held, and lowers the individual value of each share.
If you need a more in-depth explanation of stock splits, you should check out the stock splits video linked in the description.
Tesla stock split analysis
Now, let’s get to Tesla’s stock split. In 2020, as Tesla’s stock was hovering around $1,300, the firm’s founder and CEO Elon Musk noted the shares were, quote-unquote, too expensive, adding that a greater chunk
of the public should be able to afford the company’s shares. That tweet was soon followed by a 5-for-1 stock split in August last year.
Just after the split, Tesla’s shares were priced at $418 per share on average, and in December 2020, 4 months after the split, it fetched more than $625 per share, almost a 50% increase.
Analysts have suggested that affordability may not have been the only reason for the stock split that Tesla did. Tesla may have foreseen its being included in the S&P 500 Index, where stock liquidity is an important consideration. As expected Tesla was actually included in the S&P 500 in December 2020, 4 months after the split.
For an in-depth understanding of how market indices work and what market indexes are, you can check out the video that we have linked in our description.
The 2020 split was Tesla’s first ever stock split, and there are now rumours about a second one happening soon. Why? One possible reason is that another split might allow Tesla to gain admission to the coveted Dow Jones Index. Tesla’s stock has seen a surge in its prices this year despite Musk’s sale of $934,000 shares as promised as you expected to his Twitter followers. Another 5-for-1 split would bring the share price down to approximately $200 per share, since it is currently in the 1000 dollar range.
Dow Jones is a price-weighted index, the higher the price of a stock, the more weight it would hold on the index. Tesla’s stock price of nearly $1000 per share as of 2021 would make it an impractical choice to join the Dow, because its influence over the entire Dow Jones Industrials would be unjustifiably high.
To put this into perspective, the most expensive stock on the Dow as of 2021 is this company called United Health, priced at around 450 dollars, and accounts for 8% of the index. If Tesla were to join at existing prices, it would represent approximately 30% of the index! This would never be permitted.
With another stock split, Tesla’s price would plummet to roughly 200 dollars, and this could make a decent case for inclusion into the Dow.
Pros and Cons of stock split
Now that we have understood Tesla’s moves and the reasons behind them, let’s now understand the pros and cons of undertaking a stock split:
Stock Splits Increase Liquidity and Prevent High Prices
First, Stock Splits Increase Liquidity and Prevent High Prices. What it means is that stock splits increase the total amount of outstanding shares for a company by a substantial number, while the company’s market cap stays the same.
So, when Tesla, with its 1 billion shares priced at about thirteen hundred dollars split up into 5 billion shares after its stock split in 2020, the price of an existing share decreased to a more affordable level at about three-to-four hundred dollars.
Low stock prices encourage smaller investors to get into and trade the stock more often than it would be possible if the price was much higher. Although in 2021, Tesla’s stock price actually rose back up again to again the thousand dollar range.
Stock split allows companies to send a positive signal to its shareholders
The second advantage of a stock split is that it allows companies to send a positive signal to its shareholders.
When a stock splits, it is an indication of the fact that the company believes its stock prices are likely to rise even further in the future, and that it has exercised a stock split to make sure the prices are staying in check. This in turn increases the demand, and brings the prices up post-split.
In Tesla’s case this was true right? You saw that. After the split in 2020, Tesla’s stock was priced at about 400 dollars, and it shot up to the 600 dollar range within 4 months. At the end of November 2021, it is now in the 1000 dollar range.
So we looked at the pros, now, let’s look at the cons.
Stock split does not change the fundamental value of the company
The first, and probably the most ignored one, is that a stock split does not change the fundamental value of the company. Think of it as having a pizza in front of you. Regardless of the number of slices that you cut the pizza into, the size of the pizza won’t change nor will the pizza itself taste any different than before. Essentially, you will still have the same pizza in front of you. And that’s the same concept that applies to stock split.
Company’s share is likely to see increased volatility
The second con is that after a stock split, the company’s share is likely to see increased volatility, since lower prices encourage short-lived investments and day trading.
So here’s how this happens: if any stock splits, let’s say, 2 for 1, the market now has to deal with twice as much stock available for buyers and sellers of that stock.
Many times, soon after a stock is split some of those who believe that the stock is not valuable end up selling a portion of their holdings. And as more stock becomes available, it further knocks down the stock price, which tends to boost the volatility of that particular stock. In fact, many investors say that after a two-for-one split, they sell off half of their position, while keeping their original number of shares in their holdings.
Alright! So, today we learned about the pros and cons of a stock split, and the effect that a stock split has on a company’s stock. We also saw why Tesla might actually go for another split. We would like to know what you think. You think Tesla will actually do it? Drop your thoughts in the comments below.
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