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INTRO

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"Try it with a pizza," was legendary investor Warren Buffett's response to the idea of a stock split in his 1983 annual letter to Berkshire shareholders. Buffett ruled out a split, as slicing the pie into more pieces would hardly increase its value.

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Have you ever wondered why Berkshire shares are trading for more than +$600K for each share? Berkshire has never made a stock split because, in terms of shareholder value, splits don’t matter much. Buffett's claim is that splits add zero value.

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They are nothing more than a bookkeeping adjustment, having no real effect on the company's total value. Nevertheless, some investors still love them and end up losing money as a result. Don’t be that person. Keep reading.

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What Are Stock Splits?

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Let's start with the basics. I love examples. So here is one. Imagine you have a whole pizza, symbolizing a company's total value or market capitalization, which is $25 billion. Initially, this pizza remains uncut, representing one complete share of the company's stock, valued at $250 per share.

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Now, if the company decides to do a 4-for-1 stock split, it's like slicing the pizza into 4 equal portions. So, post-split, there are now 4 smaller slices, but the total pizza size (or market cap of the company) remains the same at $25 billion. Each smaller slice is now worth $62.50.

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As a result of the split, the number of shares outstanding increases from 1 to 4, maintaining the company's total value.

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Before the split:

·      Market Cap: $25 billion

·      Shares Outstanding: 1

·      Price per Share: $250

·      Earnings per Share (EPS): $5

·      Total Earnings: $500 million

After the split:

·      Market Cap: $25 billion

·      Shares Outstanding: 4

·      Price per Share: $62.50

·      Earnings per Share (EPS): $1.25

·      Total Earnings: Still $500 million

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So, even though the number of shares and the price per share change, the total value of the company and its earnings per share remain the same. It’s still the same pizza!

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Splits Don’t Create Value

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Remember, it’s still the same pizza. As mentioned before, splits are a bookkeeping adjustment. And they have no real effect on the company's total value. Buffett's aim when he first started out was to establish a group of like-minded shareholders who would focus, just as he did, on long-term value. ‍

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However, if people bought into shares of his company for reasons that had nothing to do with value - such as a stock split - they would also one day sell. Buffett was focused on the long game. He didn't (and still doesn't) want traders buying into and cashing out of Berkshire stock with high frequency.

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Nevertheless, beginner investors enjoy the perception of owning more shares after a split. It’s purely a psychological effect. Some interpret stock splits as a positive indication from management, while others believe they can enhance trading dynamics. Why? Because this makes the stock more accessible to investors, possibly boosting liquidity and accessibility. That's why post-split, stocks often see a short-term rise.

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But they add no real value! This is exactly why Buffett has never split Berkshire stock, to discourage short-term traders from becoming his shareholders. And this is exactly why you shouldn’t consider splits as a beneficial occurrence.

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Before you go, I have one more thing for you.

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Recent Splits

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Here are some notable stock splits. Some of them resulted in a surge and some didn’t. Another lesson on how splits can’t be held responsible for an increase of stock prices. In 2014, Apple executed a 7-for-1 stock split, expanding outstanding shares from around 861 million to over 6 billion. This aimed to broaden investor accessibility, resulting in a surge in share price and Apple's market cap crossing $700 billion.

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Amazon's 1999 2-for-1 stock split aimed to lower share prices, fostering affordability. Despite initial success, subsequent years saw a sharp decline, with pre-split prices only recovered by 2010.

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Google's 2014 2-for-1 split introduced non-voting shares to maintain founders' control while enabling investor engagement. The split minimally affected share prices, as Google's value steadily rose thereafter.

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In 2020, Tesla implemented a 5-for-1 split, increasing outstanding shares from about 180 million to over 900 million. This move aimed to enhance retail investor accessibility, leading to a surge in Tesla's stock price and market cap exceeding $400 billion.

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Conclusion

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In that same 1983 annual letter to shareholders, Buffett also published a list of "principles" which were to some extent aimed at attracting and keeping the investors he wanted. He and Munger pledged to be straight with investors and prudent with managing their capital, and he wanted long-term commitments from investors. As detailed in this article by Investopedia, stock splitting would go against his investment tenants.

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His goal was to profit from the long-term growth of well-selected businesses, but not from quickly jumping in and out of them. And not from financial engineering or various types of pie-splitting. Remember, stock splits do not add any real value, even if it sometimes appears otherwise. It’s still the same pizza.

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We essentially attempt to take a similar approach to investing. Learn more in a prior write-up, "How to Find Value When Evaluating Investments." And to level up your investing game, feel free to join the world’s most powerful stock market newsletter for wealth, stability, and happiness.

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Disclosure/Disclaimer

As a Tykr affiliate, Raising InvestorIQ earns from qualifying purchases. As a Seeking Alpha affiliate, Raising InvestorIQ earns from qualifying purchases.

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Information provided on this site is based on my own personal experience, research, and analysis, and it is not to be construed as professional advice. Please conduct your own research before making any investment decisions.  I am not a professional financial advisor, stockbroker, or planner, nor am I a CPA or a CFP. The contents of this site and the resources provided are for informational and entertainment purposes only and do not constitute financial, accounting, or legal advice. The author is not liable for any losses or damages related to actions or failure to act related to the content on this website.

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