Pricing: There are two components to a pricing argument for stock splits. The first is that stock splits, by altering price per share, can affect liquidity, which can change the price. Ironically, a stronger case can be made for this with reverse stock splits, where as a stock falls to low levels, say less than a dollar, folding in five or ten shares into a single share can reduce transactions costs. With high priced stocks, the argument that stock splits reduce transactions costs and increase liquidity had more resonance in the past when trading shares in less than round lots often cost substantially more than in odd numbers. In addition, an argument can be made that when share prices reach really high levels, some investors will be shut out of the stock, because they cannot afford to buy any shares in it, round lot or not. Here, a stock split, by bringing the price down to more affordable levels expands its investor base, and by doing so, its stock price. The second argument for stock splits being pricing events is that they feed momentum that is already prevalent in the stock, perhaps because of the perception that lower priced shares (even if there are more of them out there) just seem cheaper to investors. In effect, those investors (like me) who bought Apple at $75/share in 2017 and have seen it go up to $500, and are troubled by how much it has gone up in a short time period, will feel more comfortable when the stock price settles back in at around $125 after the stock split, because we compare this price (perhaps irrationally) to $75/share instead of $18.75/share. With Tesla and Apple, the fact that these splits are coming after a unprecedented run-up in both stocks suggests that the primary reason for the splits is pricing, and that it more momentum-feeding than liquidity-building. You will be able to test the latter, by tracking trading volume and bid-ask spreads on both stocks in the coming weeks, since a liquidity story should show up in higher trading volume and lower spreads (as a percent of the stock price).
Index Inclusion/Exclusion
We use stock market indices to track market movements, but we also attribute qualities to companies, based upon the indices that they are part off. Thus, a company that is part of the S&P 500 is considered to be safer and more secure, and with good reason, since market capitalization is one of the key factors that determine whether a company is part of the index. It is not the only reason, though, since based upon its market cap, Tesla should clearly be in the index, but it is not, because its cumulated profits over four consecutive quarters have never been positive, a requirement for index listing. In recent decades, another phenomenon has fed into the index game, and that is the growth in index funds and ETFS, tailored to mirror indices, often by buying shares in companies that are part of the index. When a company is added to an index, these passive investors will then buy its shares, altering both its stockholder base and the demand for its shares.
The Evidence: Not surprisingly, the evidence on index inclusion has been focused on the S&P 500, with studies examining how stock prices are impacted by a company’s inclusion in or exclusion from the index. While there are dozens of papers, the findings can be broadly summarized as follows:
– Positive or negative: The consensus view across studies is that a company that is added to the S&P 500 sees its stock price increase modestly, and that the increase is permanent, and that companies that are removed from the index see small drops in stock prices that persist. There are two caveats. The first is that this increase may be more a consequence of the circumstances that led to the the company being added on to the index than the index addition. This paper, for instance, looked at a matched sample, where companies added to the index were paired with companies with similar characteristics (high momentum, rising earnings etc.) that were not added to the index and concluded that there was no index addition effect. The second is that there seems to be some evidence that the index effect has become smaller over time, rather than larger, even as passive investing has become a larger part of the index.
– Volatility and variance: There is some evidence that a stocks that get added to the index see increased volatility, as institutions become bigger players, and move more with the index, for the obvious reason that they are now part of it.
