2 reasons to buy stock splits (and 1 reason not to)

Did you notice that Appleit is (AAPL -0.81%) the price of shares is almost always between $100 and $500, and yet the company has always generated considerable returns for its shareholders over the years?

Why isn’t the stock price higher?

Indeed, Apple has repeatedly split its shares whenever the price has risen above a certain price. In a stock split, a company divides existing shares to reduce the price per share. Imagine a pizza cut into six slices. If you were to cut each slice in half to make 12 slices, the pizza itself wouldn’t get any bigger; you would just have two smaller slices for each original slice.

This is how stock splits work.

The main reason a company would want to split its shares is to make the share price more affordable for ordinary investors and, therefore, to increase liquidity.

But since we know that the stock split itself does not change the size of the pizza (i.e. the market capitalization of the company), should you consider buying companies after a recent split ?

Image source: Getty Images.

Here are two reasons to buy stocks after a split and one reason not to.

1. You liked the company before the split was announced

The main reason to consider buying a stock after a split is announced is that you already liked the company before the split. A stock split is not an investment thesis.

This could, however, be seen as an indication of a strong company, as companies generally do not split their shares when the stock price crashes.

But overall, the stock split itself shouldn’t be the motivation to buy because it doesn’t impact the intrinsic value of the company.

For example, if you plan to buy Alphabet (GOOG -5.81%) (GOOGL -5.63%) after its recent 20-to-1 stock split, the reasoning should be that the company has an almost impenetrable moat due to its strong network effects and dominant brand recognition, or something similar.

You shouldn’t buy the stock because you think the split will make the company stronger in any way.

There is data to suggest that splits can drive up the stock price in the short term, but for long-term investors, this shouldn’t be seen as a reason to buy.

2. You’ve done your research

The main problem with using stock splits as a buy catalyst is that it can trick you into buying a stock that you have done little or no research on.

Stock research should be the foundation of your belief, so if you’re considering buying a stock after a split announcement, make sure you’ve done your homework.

For example, investors may be tempted to buy GameStop (GME -6.74%) after its recent 4-to-1 split. But if you base your buy solely on the split, you’ll be buying an extremely unprofitable company that has seen its stock completely disconnect from the underlying business due to its stock meme reputation .

In simpler terms, if you buy GameStop due to the recent stock split, you will be buying an extremely risky asset that appears to move primarily on speculation rather than trade execution.

A stock split does not magically improve the company’s prospects, so if you are buying a stock split, make sure you have done adequate research, leading you to believe that the company is a quality company that trades at a reasonable price. the price.

Don’t buy the stock thinking the split will add long-term value

Let’s all say it together: Stock splits have no impact on the underlying business.

Splits do not improve or degrade potential long-term stock returns. They can lead to a short-term movement of the price, but they have no material influence in the long term.

Therefore, you should never buy a stock just because the company has announced a split. If you’re considering buying a stock before or after a split, make sure you’ve done your research and developed a solid thesis as to why you believe deals will surpass itself.

Suzanne Frey, an executive at Alphabet, is a board member of The Motley Fool. Mark in white has no position in the stocks mentioned. The Motley Fool has positions and recommends Alphabet (A shares), Alphabet (C shares) and Apple. The Motley Fool recommends the following options: $120 long calls in March 2023 on Apple and short calls $130 in March 2023 on Apple. The Motley Fool has a disclosure policy.

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