Building Wealth

Why Investors Are Wrong About Amazon's Stock Split

It finally happened... And it's going to be a gamechanger for this stock...

Or at least, that's what many investors believe today.

But that's not entirely true.

One headline that has been dominating the news cycle lately is that Amazon (AMZN) has completed its 20-for-1 stock split. That's generated a lot of buzz around the e-commerce giant.

As a refresher, a "stock split" is a corporate action in which the number of shares in a company increases while the price of that stock decreases by the same multiple.

Here's a simple example...

If a company announces a 4-for-1 stock split, the shareholder will get three additional shares after it's completed. And the price of the original shares will be divided by four. So if the stock was trading for $400 before the split, it would trade at $100 after.

In Amazon's case, it went through a 20-for-1 stock split. That means the number of shares increased by 20 times and the price of the stock was adjusted to one-twentieth of where it closed on Friday.

Amazon was trading around $2,500 before the split. Today it trades around $125.

Now, that sounds like a better deal. After all, owning 20 shares of something sounds a lot better than owning one. (It's hard to impress someone if you say you own one measly share of a stock.)

Plus, it's easier for most folks to imagine a stock worth $125 doubling to $250... rather than a stock worth $2,500 going up to $5,000. For some reason, investors can envision lower share prices moving a lot higher than more expensive stocks.

But in the end, it's the same percentage gain.

Many investors will also argue that a lower priced stock will allow more people to buy. And that logic makes sense... Someone with a small portfolio may not be able to buy a share of Amazon when it trades for $2,500. They might have a $30,000 portfolio and they want to be diversified so no one position takes up more than 5% of the account. That eliminates any stock worth more than $1,500.

Now that Amazon trades around $125, this hypothetical investor can buy. And with many new buyers at the lower share price, it could push shares higher.

There is some evidence to support this...

Stocks in the S&P 500 Index tend to rise 5% in the year following share splits, including 2.5% immediately following the announcement, according to research from Nasdaq Inc. This research looked at stock splits between 2012 and 2018.

But don't think just because Amazon went through a stock split that it's going to magically shoot higher. It's not.

And that's because nothing has changed about the company fundamentally. Splits don't affect a company's value.

Amazon had a market cap around $1.3 trillion before the split. It has a nearly $1.3 trillion market cap today.

Also, the rise of fractional shares may not draw as many new investors to Amazon's low share price as it would in the past.

Brokerages such as Charles Schwab give clients the option of buying a fraction of a share for as little as $5. So even when Amazon was trading at $2,500, investors could still own a piece of the company for a small amount of money.

In short, if you're buying Amazon today because you believe it's going to rise after a stock split, you should re-think your strategy. Instead look at the company's fundamentals to determine if it's a buy or not.

When I review the financials and the outlook for its business – mainly its cloud-computing segment – shares look attractive to me.

But it's important to note that my outlook has absolutely nothing to do with its recent stock split.

If you want to find places to put your money to work today, my friend Joel Litman believes that we're headed for a massive and sustained new phase in the bull market... which nobody on Wall Street wants you to know about. And it could cause one particular type of investment to skyrocket.

If you want to get there first, click here for all the details.

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Here's to our health, wealth, and a great retirement,

Dr. David Eifrig and the Health & Wealth Bulletin Research Team
June 8, 2022