A stock split takes place when a company divides existing shares into multiple shares. Technically speaking, stock splits don’t change the value of a company, or their investors' holdings.
This strategy does however, reduce the price of individual shares, which can make a stock more accessible to retail investors, especially when the price of shares reach a level deemed too high for small investors.
A lower share price can make the stock more attractive to a broad range of investors, not all of whom could afford a stock priced at $1,640 in the case of the electric car-maker like Tesla. (NASDAQ:TSLA).
The rally in Tesla shares since the company announced a stock split shows the growing influence of retail investors on the market where large institutional investors have taken a back seat since the COVID-19 pandemic.
Tesla early this week announced it would split its shares in a 5-for-1 exchange, a move designed to make the stock less expensive after it soared 300% this year. Shares of Tesla closed 13.12% higher Wednesday as investors continued to rally on the stock split news. Yesterday, the stock gained just over 4.2% again, closing at $1,621.00. Tesla will start trading on a split-adjusted basis Aug. 31.
At one point last month, nearly 40,000 Robinhood account holders added shares of the car-maker during a four-hour span. The surge has been a boon to other electric-car companies, some of which have yet to actually produce a vehicle.
“The stock split is a recognition of the fact that the market is increasingly influenced by individual investors, including those looking to gain exposure to next-generation transportation,” said Ben Kallo, an analyst with Robert W. Baird who rates Tesla the equivalent of a hold, in a note carried by Bloomberg.
Retail Frenzy
With this momentum created by the stock split, Tesla shares are also in demand ahead of its widely expected inclusion in the coveted S&P 500 Index. The car-maker became eligible for an S&P 500 slot after it reported profits for four consecutive quarters. If that happens, it will make the stock a must-buy for mutual and exchange-traded funds that seek to mimic the benchmark index. At least $1.6 trillion of mutual and exchange-traded funds track the S&P, according to Morningstar Direct data.
For long-term investors who buy stocks on their fundamental strength, this is certainly not a good time to buy Tesla stock, in our view. The retail frenzy, fueled by the stay-at-home environment, has made Tesla valuation almost impossible to justify.
Tesla shares now trade at 217 times estimated 12-month earnings, versus 14 times for General Motors (NYSE:NYSE:GM). The car-maker’s market capitalization at $306 billion is more than the value of Toyota (NYSE:TM) and Ford (NYSE:F) combined.
When it comes to making a profit, it’s also worth noting that Tesla’s isn’t making more money by selling more cars.
Wall Street Journal reporter Charley Grant explains:
"Total revenue actually fell 4% from a year earlier. What's more, the company's $6 billion top line included $428 million of regulatory credit sales to help rival manufacturers meet emissions mandates. These credit sales are essentially pure profit and accounted for more than 100% of the company's operating income. A year ago, Tesla booked $111 million in second-quarter credit sales."
In fact, Tesla has barely grown revenue at all since the fourth quarter of 2018. Without zero-emission vehicle (ZEV) and other regulatory credits, Tesla would not have been able to report a fourth consecutive quarter of GAAP profitability.
Bottom Line
Tesla stock has benefited from its stock-split decision mainly because it lowers the bar for small investors. But that move changes nothing for the company’s fundamentals and its valuation, which is hard to justify when sales from its car business aren’t increasing.