Investing

Tesla Seeks Second Stock Split: What Investors Should Know

Tesla will likely join Amazon, Google and GameStop by splitting this year, but shareholders need to approve the plan first.

Tesla says it has rethought every aspect of what a car is, and every aspect of the production cycle. The result is that everything in the factory was developed in-house.
James Martin/CNET

Early last week, Tesla announced its intentions to split its stock for the second time in two years. The stock split -- though not official just yet -- would result in a lower price for Tesla shares, with more shares in circulation. Though the proposal likely won't meet much resistance, shareholder approval will be required before the company can issue share dividends to facilitate the split.

This announcement comes not long after Amazon and Google announced their own stock splits. Amazon and Google will both be splitting shares 20-to-1 (June 3 and July 1, respectively). Now, GameStop has followed suit. We don't yet know what Tesla's split ratio will be or when the split will occur. But if history is any indicator, it could occur shortly after the annual shareholder meeting that's likely to take place in early June.

Tesla would be splitting for the second time in two years -- an uncommon occurrence. The closest comparisons may be Microsoft's series of small splits throughout the 1990s, and Amazon's three splits throughout 1998 and 1999. But those series were at smaller split ratios compared with Tesla's prior split. The split announcement coincides with the openings of new factories in Berlin, Germany and Austin, Texas.

Below we'll explain what a stock split is, how it affects investors and the share price and why companies would be interested in pursuing a stock split.

Tesla announces intention to split
Tesla/Twitter

What is a stock split?

A stock split divides existing shares into smaller pieces for greater accessibility. This causes the total share count to go up and the stock price to go down. You can picture a stock split as someone cutting a freshly made pizza; cutting the pizza into slices doesn't change anything fundamentally, it just makes the pizza easier to share and eat.

In other words, consider a 5-to-1 stock split when the stock price is at $1,000. If you owned one share of the company, on the day of the stock split, that one $1,000 share would turn into five $200 shares.

How do stock splits affect options?

Options are affected the same way shares are, assuming they expire after the day of the split. For example, if you have a $1,000 strike call and a 5-to-1 split were announced, you would end up with five $200 strike calls. This scenario gives you more flexibility in your choice to exercise or sell.

Why do companies split their stock?

A company may issue a stock split for many strategic reasons. Most often, a company foresees major growth on the horizon and they want to keep shares at an accessible price for retail investors. The stock also becomes more accessible to employees who receive stock-based compensation, like they do at Tesla. The price of Tesla stock has soared 80% in the past 12 months, with the share price outpacing many investing budgets.

There can be other strategic goals as well. For instance, the Dow Jones Industrial Average, or Dow, is a prominent stock index that is price-weighted. Because stock price directly affects the weighting in this index, it is a component considered for acceptance into the Dow. Companies with high share prices may not be admitted if they will disrupt the weighting too greatly.

Stock splits shouldn't be confused with "public offerings" of stock, where new stocks are issued by the company for sale to the public to raise money to support the business.

Do stock splits raise the stock price?

Fundamentally, a stock split shouldn't have an effect on the stock price. Nothing really changes, though research from Bank of America does suggest that companies that split their stock perform roughly 16% better than other companies in the 12 months following a split, according to Reuters. 

However, this could be an indirect correlation and may be related in part or in full to the company's growth and other factors. Stock splits generally signal that the company is growing and confident. But those who trade stock and options often take advantage of the split environment for trading, which can create a lot of volatility in the markets before and after the split. 

How will Tesla's stock split? 

For this stock split, Tesla and its shareholders will have to take a few extra steps compared with last time, when the board simply announced its decision on Aug. 11, 2020, and swiftly split the stock on Aug. 31, 2020.

Public companies are capped with respect to how many shares they are allowed to have in circulation, which is enforced by the SEC. Tesla is near its limit after the last split and public offering (in December 2020) and only has the bandwidth to issue a 2-to-1 split under current conditions without shareholder approval. This signals Tesla intends to announce a higher multiplier.

After that, the board of directors will vote to approve a stock split and likely announce it shortly after. The split will be completed by the issuance of a share dividend to stockholders. For example, if the split were another 5-to-1, then for each share you hold by the cutoff date, you'll be issued four more shares on the day of the split. It's important to note that this is a one-time share dividend, unlike recurring cash dividends that are familiar to many investors.