Between the US market closing on August 24 and it opening on August 25, electric car company Tesla (NASDAQ: TSLA) executed a three-for-one stock split. At some point in that time frame investors checked their brokerage accounts only to find that they suddenly had three times as many shares as they did before the split. The only downside? Each share was only worth about one-third as much as it was before.
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That’s how stock splits work. At their core, they are simply a way to slice up a company’s ownership a little differently than before. They don’t directly add value to a business, but they can still add some benefits both to the company and its investors.
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How a split can help
In the proxy filing proposing the split, Tesla indicated that “We believe the Stock Split would help reset the market price of our common stock so that our employees will have more flexibility in managing their equity, all of which, in our view, may help maximize stockholder value. In addition, as retail investors have expressed a high level of interest in investing in our stock, we believe the Stock Split will also make our common stock more accessible to our retail shareholders.”
When it comes to the company, as the proxy points out, the split makes it easier for it to manage its stock-based compensation program for many of the same reasons. With a share price around $270, it’s much simpler for the company to tightly manage the size of its share based offerings than it was when those shares traded above $800 before the split.
In other words, Tesla recognizes that it’s often easier for people to deal with full shares when managing their holdings. While many brokerages in the USA now offer the ability to buy and sell fractional shares, it’s not always possible -- or easy -- to do so. The lower share price makes it easier for people to make smaller transactions and have more granular control over what they’re buying and selling.
This can be incredibly helpful when it comes to tax management, particularly for those investors who can’t trade in fractional shares. In many countries, when investors sell stock that they own, they have to pay taxes on any gains they receive from owning those shares.
Imagine you bought one share of Tesla well before its split, for $300. After the split, that share became three shares, and your purchase price changed to $100 per new share. If you needed to raise $400 to cover an expense, you could sell two of your shares for $270 each, receive $540 for the sale, and owe taxes on your gain of $340 ($170 of gain per share, times two shares). You would still hold on to your remaining share.
If the split never happened, yet you needed to sell your investment to raise money, you would be selling your one share for $800. You would then owe taxes on your gain of $500 from your original purchase price. That’s a higher tax cost, simply because you couldn’t break apart your investment into a smaller piece.
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Beyond that, stock splits mean very little
Aside from those few edge cases, stock splits mean very little for most people, most of the time. If you own $1,000 of a stock before it splits, you’ll still own around $1,000 after it splits -- give or take any market movements that may happen. The number of shares you own moves in one direction, while the price of those shares moves in the other.
As a result, it’s important to recognize that Tesla’s stock split doesn’t change the overall trajectory of the company or the value of your investment if you own it. It’s an exciting headline, and it makes it easier to buy and sell individual shares of the stock, but it means almost nothing to the company or its prospects.
At the time of publication, Chuck Saletta had no investment position in Tesla.
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Sources – Forbes, CNBC, US Securities and Exchange Comission, Yahoo Finance
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