Companies that have completed or announced stock splits in recent times have soared. Stock splits lower the price of individual share prices without changing the overall market value of a company. The trend hasn't remained in one sector but spanned from consumer goods to restaurant operators to technology.
Walmart launched its stock split earlier this year, while chip designer Nvidia (NVDA 0.25%) completed one a few weeks ago. Chipotle Mexican Grill will execute one next week, and semiconductor company Broadcom will launch its split next month.
All of these stocks have climbed in the double digits this year with the exception of Nvidia, which has soared in the triple digits. It's clear that investors are excited about these companies' futures -- but does that mean you should rush out and buy Nvidia, as well as companies that might announce or have announced a split?
Image source: Getty Images.
Why do companies launch stock splits?
First, let's talk a bit about stock splits, in general, and what they mean for a company. Each of the companies I mentioned above announced a forward stock split that involves offering additional shares to current shareholders. The goal is to lower the per-share price, making the stock more accessible to a broader range of investors.
If you owned the shares prior to the split, the value of your holding won't change after it occurs -- but the number of shares you own will, according to the ratio of the split. In a 10-for-1 stock split, for example, the company will issue nine more shares to you for each one you own. Nvidia and Broadcom each announced a 10-for-1 ratio, with the idea of bringing the price of shares that had reached beyond $1,000 down to less than $200.
Nvidia's stock now trades for about $130 a share, and considering Broadcom's current price of $1,807, the company's stock should trade for about $180 when it completes its split. This price could change somewhat according to the stock's movement leading up to the stock split.
How to explain the gains
Though companies that have announced splits are roaring higher this year, stock splits themselves aren't a catalyst for share-price movement. That's because they're mechanical operations and don't change anything fundamental about a company. So how can we explain the stock-split stocks' recent gains?
It's important to remember that companies generally plan a stock split when things have been going well. The share price has advanced, and that's usually thanks to earnings growth over time. These companies are optimistic that, after lowering the high-flying share price, the stock again will enter a new phase of growth, due to concrete reasons like bright earnings prospects and demand for their products or services.
The top performance we've seen among stock-split stocks isn't linked to the split itself but, instead, to ongoing optimism about the companies' track records and future prospects.
Stocks to watch
What we can conclude is that stock splits alert us to companies that have been successful over time, and this means they're the ones to watch and consider. But this doesn't mean we should automatically rush out and buy every stock-split player.
It's important to consider each company's path so far, the market environment, and its long-term outlook. Past successes don't automatically equal future ones, no matter how optimistic the particular company is, so you'll want to examine each stock-split stock on a case-by-case basis.
Other things to consider are your familiarity with the industry in which the company operates and your investment style. If, for instance, you aren't knowledgeable about the chip industry and are a very cautious investor, Nvidia may not be the best choice for you. It's essential to understand a company and how it fits into its industry because this will help you make the best investment moves over time.
Yes, right now, stock-split stocks are on fire and attracting the eyes of investors. But if you want to score a long-term win -- and these generally offer you the best returns -- it's key to keep a cool head and choose a stock for its earnings strength and potential years down the road -- not because it just announced a stock split.
