The Meaning of Stock Splits

Apple Store

Last week Apple announced that it would undertake a 7-for-1 stock split in June. Such a split will result in every Apple shareholder will getting six additional shares for each one that they hold when the split takes place, and as a result the price of Apple’s shares will start trading at one seventh of their price before the split. In other words, since shareholders will have 7 times as many shares at one seventh of the price, the value of their holdings won’t change.

So why would a company like Apple want to do a split if it doesn’t affect the stock’s value? Matt Yglesias at Vox wrote a good explainer detailing the reasons.  Companies generally split their stock to reduce the price so that it’s slightly easier for people to buy and sell in round numbers of shares. Apple had the additional motivation that its split increases the chances that it will be included in the Dow Jones Industrial Average. There can also be aesthetic benefits to having a stock price that’s not perceived as “too high” or “too low”: in 2011 Citigroup pulled off a 1-for-10 reverse stock split to increase the price of the its stock after its plunge during the financial crisis.

The overall effects of these changes, however, are minuscule compared with other factors that affect stock prices, such as companies’ profitability, financial condition, and growth prospects. Stock splits change a few numbers around, but they don’t affect shareholders in any meaningful way.

What Just Happened to Google’s Stock?

Google Search

If you own stock in Google, you may have noticed something a bit odd: what used to be shares in GOOG stock on Thursday became shares in both GOOG and GOOGL, each worth about half as much as the GOOG shares used to be worth. What happened?

What happened was basically some financial trickery by Google founders Larry Page and Sergei Brin to make sure that they retain control of the company. Ordinarily when someone owns a stock, the financial investment comes with the right to vote on issues such as who should be on the company’s board of directors. As companies issue more shares of stock over time—perhaps to give stock grants to their employees or fund acquisitions of other companies—the voting power of the founders decreases.

Google’s founders didn’t want this to happen to them, so they split their stock into shares that have voting rights (GOOGL) and shares that don’t (GOOG). Now when they issue more stock, they can simply issue more of the ones without voting rights so that their voting power isn’t affected.

For investors in Google (and the many other companies that use similar ploys, such as Facebook and LinkedIn) this change may not be good news. Many executives have a tendency to grow their company and therefore enhance their power even if it’s not in the best interests of their shareholders (the technical term for this practice is “empire building”). Critics might contend, for example, that the money used for Google’s attempts to build self-driving cars or Facebook’s $19 billion acquisition of the messaging company WhatsApp could have been better utilized by simply returning it to shareholders.

Google’s tactics do have defenders, however: some argue that by not having to worry about losing control of their company to activist investors who are too focused on the short-term, cementing control of a company’s voting rights can allow founders to stay focused on the company’s long-term goals. So far investors seem to be buying this argument: Google, Facebook, and LinkedIn have substantially outperformed both other technology stocks and the broader S&P 500 index since the start of last year. Whether they’ll continue to outperform as the companies grow and the founders retain full control remains to be seen.