The Resurgence of Stock Splits: Why They Matter and How They Impact Investors

Stock splits have been making a comeback in the market recently, with some major companies like Walmart, Nvidia, and Chipotle announcing splits in their shares. But why do stock splits matter, and why do they affect stock prices when they shouldn’t?

In a rational sense, a stock split should not matter to investors. It simply changes the number of shares outstanding and adjusts the share price proportionately to maintain the total value of the company. However, research in behavioral economics shows that humans tend to think in absolute terms rather than relative terms, leading us to perceive “cheaper” stocks as more of a bargain.

This cognitive bias, known as non-proportional thinking, explains why stock splits can impact stock prices in the short term, even though nothing fundamental has changed about the company. Companies often cite reasons like engaging more retail investors or increasing liquidity as motivations for splitting their shares, but the real impact comes from how investors perceive the change in share price.

Interestingly, companies like Chipotle have specific goals in mind when splitting their shares, such as making employee stock awards more feasible. Chipotle’s 50-for-1 split was aimed at reducing the share price to allow for stock awards to long-term employees.

While stock splits may not have a long-term impact on a company’s value, they can lead to short-term price volatility due to our inherent biases in how we perceive stock prices. As more companies announce plans to split their shares, it’s important for investors to understand the psychological factors at play and not get caught up in the hype surrounding stock splits.

Overall, stock splits may be back in vogue, but investors should remember that they are largely immaterial in the grand scheme of things. It’s our own mental shortcuts that drive the price movements surrounding stock splits, not any fundamental change in the company’s value.