Since its founding 27 years ago, Amazon has been consistently clear-eyed about human motivation.
From understanding that readers would value selection and affordability over their neighborhood bookstores, to the power of free shipping as an incentive to sell Prime subscriptions, to promising investors huge future profits in exchange for anemic present growth, Amazon has bet on the power of rational, economically driven decision-making.
But when it comes to splitting its stock, Amazon seems to eschew logical thinking and instead rely on folk wisdom.
To be clear, Amazon hasn’t announced its intention to split its stock. But it has been rumored for weeks, and with its shares trading at $3,291 as of yesterday’s close (May 7), old-fashioned thinking makes it a candidate for a split. If Amazon goes down that road, however, its motivations may be non-financial in nature.
Why do companies split their stock?
Once upon a time, when investors bought shares from stockbrokers, companies would occasionally split their stocks. They would double, or sometimes triple, their numbers of shares, and give investors one or more new shares for every share they owned.
There was very little cost to the company, but cutting the value of shares in half—so a stock that previously traded at $100 would sell for $50—made them more affordable for ordinary investors intimidated by high share prices. Lower prices also meant lower brokerage commissions for retail investors. Lower-priced shares meant more buyers, and companies with high share prices could reliably depend on splitting its stock to give its shares a nice bump.
That practice, however, makes less and less sense as investors increasingly own shares in aggregate, through mutual funds or ETFs, buy fractions of shares, and trade them electronically on no-commission platforms. As a result, stock splitting has fallen steadily over the last 20 years. According to a study by Morgan Stanley, in 2000 there were 60 splits or reverse splits—a maneuver when companies with very low prices halve their share counts to double their prices—and less than 10 last year.
“If markets were fully efficient, and people were rational—especially today when people can buy fractional shares—it shouldn’t matter, ” says Kelly Shue, a professor of finance at the Yale School of Management.
But companies still hold out hope that splitting will sprinkle some pixie dust on their share prices. Canadian Pacific Railways, which trades at about $395 a share, announced a five-to-one split in January. “We believe that the share split will encourage greater liquidity for CP’s common shares and provide opportunities for ownership by a wider group of investors than is currently available,” CEO Keith Creel said in a statement.
In what is sort of the market equivalent of muscle memory, because investors are aware of the historic benefit of stock splits, shares do still move when companies announce their intention to split. According to Morgan Stanley, which looked at 450 companies that split their shares over the last 20 years, companies outperform the S&P 500 by a median of 2.4% after the announce their intention to split, and then by 4.7% for six months after the effective date, although that benefit has dwindled in recent years.
Why does Amazon want to split its shares?
It’s hard to make the argument that Amazon is undervalued, or that a lower price might attract more shareholder interest. With the world’s third highest market cap, Amazon is hardly flying beneath the radar. As of March 1, its shares were the tenth most held on Robinhood, an app favored by small investors.
One possible motivation for Amazon would be gaining entry into the Dow Jones Industrial Average, the group of 30 blue chip stocks used as a benchmark for the broader stock market for more than a century. Because the Dow is an index weighted by price, it won’t admit companies with very high share prices because it distorts the weighting. Membership in the Dow signals a company is part of a club of established, stable institutions, and that may be attractive to Amazon. Still, given that Amazon is larger than almost every company in the Dow (save Apple and Microsoft), it’s not clear what actual benefits its membership would bring.
If Amazon’s goal is entry in the Dow, a simple split wouldn’t work, either. It would have to consider something much bolder, like a 10-to-1 or 20-to-1 split, to bring its prices more in line with other Dow components. Shares of Dow companies are priced between $416 (for UnitedHealth) to $53 (for Cisco) as of yesterday.
Amazon has split its shares before—three times, in fact, all between 1997 and 1999, when it was a company still hungry for investors and validation from Wall Street. Now, it’s a much different company, and its four-digit share price is a testament to its vertiginous climb, something it would lose in a split.
“A very high stock price is way to remind investors to remind people they have had a great run up,” Shue said. “It’s a reminder that they have had a great history.”
The unintended consequences of spitting shares
Another reason companies want to split their shares is to make them less volatile, Shue said. In theory, the more investors that own the stock, the less chance there is of any significant number of them buying or selling at once and sending shares soaring of plummeting.
Shue’s research, however, shows the opposite. Stocks splits can make shares more volatile, because shareholders pay more attention to changes in price than changes in percentages, she wrote in a 2019 paper with co-author Richard Townsend. Investors tend to evaluate news about a company in terms of the dollar impact on its stock price, and for example will price news about a new CEO at a $1 a share, regardless of the cost of the stock. A lower priced stock will have a correspondingly larger price bump because a $1 change means more. This works for reverse splits too, they found, and doubling a stock’s price reduced its volatility by 20% to 30%.
For that reason, company executives should be in favor of splits, Shue said. For executives holding options that vest when the companies stock reaches a certain price, the more volatile the shares, the more likely they will crest the magic number that allows them to exercise their option. Given that Amazon’s shares have been a runaway train in recent years—nearly doubling since 2019—it’s hard to imagine its executives need to resort to such ploys to cash in their shares.