Tesla, the world‘s leading electric vehicle (EV) manufacturer, has been one of the hottest stocks in recent years. The company‘s share price has soared as investors have bet on the long-term growth potential of the EV market and Tesla‘s ability to maintain its leadership position.
One factor that has contributed to the excitement around Tesla stock has been the company‘s willingness to split its shares. In August 2020, Tesla executed a 5-for-1 stock split. Two years later, in August 2022, it followed up with a 3-for-1 split. These corporate actions have made headlines and sparked renewed interest in the stock.
But what exactly are stock splits, and what do they mean for Tesla investors? In this article, we‘ll take an in-depth look at the mechanics and motivations behind stock splits, analyze Tesla‘s splits specifically, and discuss the implications for shareholders.
Understanding Stock Splits
A stock split is a decision by a company‘s board of directors to increase the number of outstanding shares by issuing more shares to existing investors. In a 2-for-1 split, for example, every shareholder receives an additional share for each share they own. The stock‘s price is then halved so that the total market capitalization (share price multiplied by number of outstanding shares) remains the same.
Imagine a company with 10 million shares outstanding and a stock price of $100 per share. The market cap would be $1 billion (10 million x $100). After a 2-for-1 split, the number of shares would double to 20 million, but the price would be adjusted to $50, maintaining the $1 billion market cap (20 million x $50).
The key thing to understand about stock splits is that they don‘t directly impact a company‘s underlying fundamentals or change the total value of an investor‘s holdings. They simply divide the same company into more individual shares. An analogy would be exchanging a $10 bill for two $5 bills – you still have $10 in total.
So why do companies split their stocks? The main reason is to make the shares more affordable and accessible to a broader base of investors, especially retail investors who may be put off by a high nominal share price. Companies also believe that having a larger number of shares outstanding can improve liquidity and trading volume.
There is some academic research to support the idea that stock splits can have a positive impact on share prices, at least in the short term. A study published in the Journal of Financial Economics in 2019 found that stocks that split outperformed the market by an average of 4.4% over the following year, even after controlling for factors like size and momentum.
However, it‘s important to note that these effects are not guaranteed or persistent. Ultimately, a company‘s long-term stock price performance will depend much more on its earnings, growth, and competitive positioning than on how many shares it has outstanding.
Tesla‘s Stock Split History
Now let‘s take a closer look at Tesla‘s experience with stock splits. As mentioned, the company has split its stock twice in recent years. Here‘s how those splits have impacted the number of shares outstanding and stock price:
| Date | Split Ratio | Pre-Split Shares (mn) | Post-Split Shares (mn) | Pre-Split Price | Post-Split Price |
|---|---|---|---|---|---|
| August 2020 | 5-for-1 | 186 | 930 | $2,213.40 | $442.68 |
| August 2022 | 3-for-1 | 1,034 | 3,100 | $891.29 | $297.10 |
As you can see, Tesla‘s first split in 2020 increased the number of outstanding shares by a factor of five while reducing the stock price by 80%. The second split in 2022 tripled the share count and cut the stock price by two thirds.
If we look at Tesla‘s stock price on a split-adjusted basis, we can see how much the stock has appreciated over time. Just prior to the first split in August 2020, Tesla shares traded around $2,200. Adjusted for the 5-for-1 split, that‘s equivalent to around $440 per share.
Fast forward to just before the second split in August 2022. The stock was trading at about $900 per share, which equates to around $1,800 on a pre-first split basis ($900 x 2 = $1,800).
As of March 2023, with the stock at around $190 per share post-second split, that translates to $570 on a post-first split basis ($190 x 3 = $570), and $2,850 on a pre-both splits basis ($570 x 5 = $2,850). In other words, an investor who owned just one share of Tesla prior to the first split in 2020 would now have 15 shares worth a total of $2,850!
Here‘s a table summarizing Tesla‘s stock price at key points in time, adjusted for splits:
| Date | Split-Adjusted Price | Basis |
|---|---|---|
| August 2020 (pre-1st split) | $2,213.40 | Pre-both splits |
| August 2020 (post-1st split) | $442.68 | Post-1st split |
| August 2022 (pre-2nd split) | $1,782.58 | Pre-2nd split |
| August 2022 (post-2nd split) | $297.10 | Post-both splits |
| March 2023 | $2,850 | Pre-both splits |
Of course, most investors didn‘t hold Tesla stock prior to the first split, let alone at the IPO price of $17 per share back in 2010. But this exercise highlights just how dramatically Tesla shares have appreciated in a relatively short period of time, even accounting for the splits.
The Psychology of Stock Splits
So why did Tesla choose to split its stock, not once but twice? And why might it do so again in the future? To answer these questions, it helps to understand the psychology behind stock splits.
Even though stock splits don‘t fundamentally change a company‘s valuation, there is evidence that they can impact investor behavior and market sentiment. Retail investors, in particular, may perceive a stock with a lower share price as being more affordable and attractive, even if the underlying company‘s size hasn‘t changed.
There is also a belief among some executives and investors that a stock split can generate publicity and excitement around a company. When a high-flying stock like Tesla announces a split, it often makes headlines and can spur increased trading activity. Some companies may view this as a way to keep their stock in the spotlight and maintain positive momentum.
Elon Musk, Tesla‘s CEO, has been especially savvy in using Twitter and other public forums to promote Tesla stock and engage with retail investors. He‘s cultivated an almost cult-like following among many Tesla shareholders who view him as a visionary leader. Musk seems to understand the psychological impact of stock splits and how they can make Tesla shares feel more accessible to the masses.
Here‘s a telling quote from Tesla‘s announcement of its latest stock split in 2022:
"We believe the Stock Split would help reset the market price of our common stock so that our employees will have more flexibility in managing their equity, all of which, in our view, may help maximize stockholder value. In addition, as retail investors have expressed a high level of interest in investing in our stock, we believe the Stock Split will also make our common stock more accessible to our retail shareholders."
Clearly, Tesla sees its stock splits as a way to not only reward existing shareholders but also to attract new ones, particularly retail investors who might otherwise be put off by the high nominal share price. And so far, this strategy seems to have paid off, as Tesla‘s stock has continued to climb higher following each split.
Stock Splits and Valuation Metrics
One common misconception about stock splits is that they make a company more valuable. In reality, a stock split doesn‘t directly impact a firm‘s market capitalization or enterprise value. It simply changes the number of slices into which that value is divided.
However, stock splits can indirectly impact certain valuation metrics that investors use to assess a company‘s worth. For example, a common valuation metric is the price-to-earnings (P/E) ratio, which is calculated by dividing a company‘s stock price by its earnings per share (EPS).
Since a stock split doesn‘t change a company‘s total earnings, the split will cause its EPS to decline by the split factor. So in a 2-for-1 split, the EPS will be cut in half. Assuming no change in the stock price, this will cause the P/E ratio to double.
Here‘s a hypothetical example. Let‘s say a company has $1 billion in net income and 100 million shares outstanding, giving it an EPS of $10 ($1 billion / 100 million). If the stock trades at $100 per share, the P/E ratio would be 10 ($100 / $10).
After a 2-for-1 split, the company would have 200 million shares outstanding and an EPS of $5 ($1 billion / 200 million). If the stock price remained at $100, the new P/E ratio would be 20 ($100 / $5).
In Tesla‘s case, the company‘s P/E ratio has bounced around quite a bit in recent years due to the impact of the stock splits as well as swings in earnings. Here‘s a look at Tesla‘s P/E ratio at various points in time:
| Date | Stock Price | Shares Outstanding (mn) | Net Income (ttm, $bn) | EPS (ttm) | P/E Ratio |
|---|---|---|---|---|---|
| 6/30/20 | $1,079 | 186 | $0.4 | $2.15 | 501.9 |
| 9/30/20 | $429 | 930 | $0.6 | $0.64 | 669.4 |
| 6/30/22 | $737 | 1,034 | $9.6 | $9.29 | 79.3 |
| 9/30/22 | $265 | 3,100 | $11.8 | $3.81 | 69.6 |
As you can see, Tesla‘s P/E ratio has generally trended lower over time as the company has become consistently profitable and its earnings have grown. The stock splits have periodically caused the ratio to jump higher, but the long-term trend has been downward.
It‘s worth noting that even after the decline in its P/E ratio, Tesla still trades at a significant premium to most other auto companies. Tesla‘s current P/E is around 50, compared to P/E ratios in the single digits or low teens for established automakers like General Motors and Ford. This reflects the market‘s bullish view on Tesla‘s growth prospects relative to the legacy auto industry.
Conclusion
Stock splits are a common yet often misunderstood corporate action. While they don‘t directly change a company‘s underlying fundamentals, they can impact investor psychology and market perception. This seems to have been the case with Tesla, which has seen its stock price continue to soar following each of its recent splits.
For current and prospective Tesla shareholders, the key takeaway is that stock splits shouldn‘t be the primary driver of an investment decision. Ultimately, Tesla‘s long-term performance will depend on factors like the growth of the EV market, the company‘s ability to expand production and maintain its competitive edge, and its success in achieving consistent profitability.
That said, Tesla‘s stock splits do offer some potential benefits for investors. The lower nominal share price makes the stock more accessible to retail investors and could help attract new buyers. The splits also improve liquidity and make it easier for existing shareholders to sell part of their stake if needed.
Looking ahead, Tesla‘s stock price will likely remain volatile as the company navigates the challenges and opportunities of the fast-growing EV industry. But for long-term investors who believe in Tesla‘s vision and execution, the stock splits are just one more reason to feel optimistic about the company‘s future.
