Is $Tesla Motors(TSLA)$ bananas (crazy) to contemplate a stock-split not even two years after the last one in Aug 2020? Let's see...
Bananas to Split?
Stock-split technically should have no effect on the company value. If one owned a share of TSLA, in a 5-to-1 split, one is issued four additional shares. The total number of TSLA shares outstanding increased by a factor of 5, and market re-set share price at one fifth of its previous level. The exercise left the value of one’s holdings, and market value unchanged. If there is a “pop” in share price, it's likely temporarily and short-lived, there could even be negative returns once the euphoria died down.
This seems to be the conventional wisdom in US markets, with companies announcing stock-split reducing over the years, from average high of 81 to 10 (see graph below).
Stock-splits decreasing trend 1990-2017, source: Forbes article, George Calhoun
Alpha from Split?
In the case of TSLA however, the “pop” was an extraordinary source of abnormal returns or alpha –measure of outperformance or excess return of investment relative to a market benchmark, in this case S&P 500.
If one bought Tesla the day after the stock-split announcement on 11 Aug 2020, one would have realised an extraordinary 40-60% gain above the market average in just a couple weeks (see chart below).
TSLA +60% alpha from split announcement to execution, source: Forbes article, George Calhoun
Academic studies that examined hundreds of stock-splits over decades seem to also support that this stock-split alpha is a real phenomenon. The above-market returns persist for a long period, up to average three years (see graph below).
Academic studies showed stock-splits gave abnormal returns, source: Forbes article, George Calhoun
Thus, it's worth revisiting the two main arguments for stock-splits, to understand the abnormal returns or alpha:
- Liquidity Improvement – Lower the stock price to (1) make it easier to trade because of higher volumes, (2) appeal more to retail investors, due to perceived affordable stock price, and (3) cater to institutional players carrying out larger-scale transactions or balancing of portfolios held by funds to mirror indices.
- Signalling Positive Expectations– Inviting more to invest in the company projects confidence in its operational health and future growth potential. It grabs the attention of the market and prompts positive reassessment by analysts, which in turn drives company’s valuation higher and outlook upgrades.
Given these possible positive returns, it's not inconceivable that stock-splits are now back in fashion, with $Alphabet(GOOG)$ and $Amazon.com(AMZN)$ also announcing stock-split plans in recent months.
TSLA's Alpha
So, TSLA stock-split plan is really an invitation to ramp up investment in the growing company confident in its production and financials, and a signal of its upside potential. If the last split is any indication, this next one might be just as bananas (wildly enthusiastic), given the often frenzied buzz around all things TSLA.
$Tesla Motors(TSLA)$ and investors alike would more likely than not, find abnormal, extraordinary (add your own superlatives) alpha in its next stock-split. Now that would be just bananas (crazy)!
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