Apple In The Dow?

Apr.24.14 | About: Apple Inc. (AAPL)

Just weeks after Google (NASDAQ:GOOG) (NASDAQ:GOOGL) split its shares, Apple (NASDAQ:AAPL) announced a stock split of its own. Apple is splitting its shares seven-for-one, which will bring the stock price down to somewhere around $80 per share.

From an economic perspective, a stock split is meaningless. It’s a bit like a baker who slices a pie. Slicing the pie creates more pieces and it even makes it easier to eat, but at the end of the day, it’s still just one pie. The same is true for a stock split. There are more shares after the split, but the market capitalization (i.e., the sum of the value of the shares) doesn’t change. So why split the stock?

One often heard argument is that a stock split does increase the market cap because it makes the stock more marketable. In other words, investors are more willing to buy an $80 stock than than a $560 stock. If this is indeed true, then demand for the shares increases and they will appreciate at a higher rate than they would have if there had been no split.

However, this argument is largely fallacious and there is little empirical evidence supporting it. At the very most, a stock split might signal management’s optimism about the company’s future prospects. After all, management probably wouldn’t split the shares if they thought the business was about to hit a rough patch and the stock price was about to fall. But if a split sends a signal, it probably won’t cause much more than a temporary rise in the stock price. Besides, there are other and more effective ways for management to signal its optimism. It could just say so in a press release or conference call. Or, it could increase the dividend or buyback shares. (Apple is doing these things, too).

I heard one reporter on the radio argue that Apple’s stock split means that ordinary investors will finally be able to afford the stock. He said that at the current price, a 100 shares of stock costs a fortune; but after the split, more people will be able to buy 100 shares. This is a ridiculous argument. The last time I checked, there was no law that said you had to buy 100 shares at a time. Many years ago, investors did pay a bit of a penalty if they bought anything other than round lots (i.e., 100 share increments). Today, thanks to internet brokers, in most cases, it costs less than $10 no matter how many shares you buy. So, yes, the commission per share is higher if you buy fewer shares, but it’s still very low.

In one regard, however, Apple’s stock split does make sense. By splitting the stock and bringing the price down to a more common level, Apple becomes eligible for membership in the prestigious Dow Jones Industrial Average. Unlike most other indexes, the Dow is price weighted. This means that higher priced stocks carry more weight in the index. The Dow committee is not likely to add a $500 stock to the index. Now that Apple is splitting the shares, don’t be surprised if it becomes a member of the Dow index.