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GameStop Corp.
GME
is doing a four-for-one stock split in the form of a dividend, mimicking a trend that’s become more popular over recent years.

Companies including Apple
AAPL
, Tesla
TSLA
, and Amazon
AMZN
have also done stock splits recently, enticing new investors who view a split as an opportunity to scoop up additional shares at a more reasonable price.

GameStop first indicated its plan to split the stock in March 2022, causing a temporary 22% spike in overnight trading to $203.98. Yesterday the stock closed at $117.43. Will today’s rally prove ephemeral as well?

This really begs another important question, and that’s whether investors ought to view stock splits as a bullish catalyst for buying a stock in the first place?

The Case Against Stock Splits

Most professional investors aren’t very enthusiastic about the idea of a company splitting its stock. Some see it as a deliberate smoke and mirrors act by management intended to lure naïve retail investors into supporting a stock.

In March, GameStop said the split would “provide flexibility for future corporate needs,” whatever that means.

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The best reason to be skeptical of stock splits is because they do nothing to change your proportional ownership of the company. For example, if a stock is priced at $100 per share and there are one million shares outstanding, the company would have a market capitalization value of $100 million.

If that same hypothetical company decides to issue four times as many shares, the stock price would fall to $25 and there would be four million shares outstanding. Thus, after the “split” the company is still worth $100 million, and your proportionate ownership would still be the same. The only difference is now you own four times as many shares at a lower price.

See why the whole thing is kind of silly?

GameStop became the posterchild for the meme stock craze that gripped markets post-pandemic. In 2022, that trade is no longer working. Thus, GameStop bears could see today’s news as a desperate attempt by management to stall the decline.

The Case For Stock Splits

The best reason to be bullish after a stock split is the simple fact that companies that have done them in the past have subsequently outperformed.

Since 1980, there have been 1,461 companies from the S&P 500 index that have done stock splits. Interestingly, those stocks have outperformed on average over multiple time durations.

If stock splits are just a hollow exercise of shifting numbers around to artificially pump up a stock, how do we explain the fact that companies that do them have averaged more than double the market’s return two years later?

I’ll admit I was skeptical about stock splits when I started writing this piece. Until my analyst crunched the numbers, I thought this piece was only going to make a case for why investors should fade the notion of using stock split news as a bullish catalyst. But the data argues differently.

Maybe stock splits work because they actually do make it easier for everyday investors to buy shares?

Or, maybe stock splits work for coincidental reasons.

For example, maybe this leads you into a basket of companies with strong momentum, which has been a well documented alpha factor in academic studies. Stocks usually split after they’ve been performing well and the share price has risen, right?

Whatever the case, most investment decisions are nuanced. That’s why I wouldn’t advise anyone to buy or sell GameStop on the stock split news alone. Split or no split, GameStop remains a turnaround story with an uncertain future, and that’s a risky setup in a highly uncertain investing climate like we have today.

On the other hand, if you liked GameStop’s investment merits before the split, you can lean even more bullish now that you know most companies that do splits subsequently outperform.

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