In 2022, three of the largest and wealthiest tech companies in the world have announced or completed their plans for stock splits. Specifically, Amazon executed its stock split last Monday, while Alphabet and Tesla are expected to do so later in the year. There is a wide range of reasons why a firm would enact to alter its number of shares in circulation, but the outcome has not always proved beneficial. Therefore, why are tech companies tilting towards that direction and what should investors look out for?

What is a stock split and why do companies use it?

A stock split is a corporate action in which a company divides the number of its existing shares in issue into multiple new shares according to a predetermined ratio. This move is designed to reduce the price of each share without impacting the overall value of the business as the fundamentals of the company remain intact.

Thus, companies proceed with stock splits when their share price achieves or hovers near record highs to allow retail investors to step into the market, increasing demand and consequently liquidity. However, evidence from a recent analysis by the Chicago Board Options Exchange suggests that volume in mega-cap equities initially jumped 342% on average the week commencing the split date, but demand faded over the next six months, implying that the pop in retail popularity could be temporary.

In addition, stock splits for major companies such as Amazon and Alphabet could increase their chances of being accepted to the Dow Jones index. That is because the group of the 30 leading and most influential American enterprises is a price weighted index instead of a market capitalization weighted index.

What should investors watch out for in the upcoming barrage of stock splits?

For existing shareholders, stock splits do not change their net value, but the increasing demand triggered by more affordable prices could eventually lead to gains. Furthermore, the spike in demand could prove beneficial for investors that wanted to liquidate part of their shares to invest in other assets or even cash out some of their profits.

The share price’s initial boost after a stock split is proven historically. Since 1980 the S&P 500 companies that announced splits have outperformed the index by 16 percentage points on average over the following 12 months. Hence, for investors who consider buying shares of a company, a stock split could potentially provide additional motivation, but the timing of the investment could play a substantial role as the bump in equity prices could prove short-lived.

Amazon the latest example

In early March, Amazon announced its first stock split since 1999, which would be effective after the close of trading on June 3, following the announcements of other tech behemoths. One of the main reasons the firm decided to proceed with this move was to make the share price more accessible for retail investors. Although the stock price propelled higher immediately after the news, it is currently trading 16% down from its pre-announcement levels. Moreover, the share price also lost ground  after the execution of the split.

This development comes in contrast with the theory behind stock splits and their consequent effect on share prices. However, much of the stock’s weakness could be attributed to the current negative macro environment, which is constantly deteriorating for risky assets. In an effort to partially offset these losses, Amazon is planning to launch a new $10 billion buyback program, which would be the largest repurchase authorization in the firm’s history.