In late January, the financial world was abuzz with the news that Kim Kardashian’s shoe rental company launched its first retail kiosk at an L.A. mall! No, wait, wrong headline – Warren Buffett’s Berkshire Hathaway B shares underwent a 50-for-1 split! The shares, which had been trading just below the $3500 mark, split on January 21 and began trading around $70. Wow, seems like a great deal, doesn’t it? In the sense that a single share seems more affordable, yes. The operative word there is “seems.” Stock splits don’t affect the value of the company or its market cap (and if you’ll notice, 3500/50 = 70). To borrow an analogy from a coworker, think of the company as a pie. You could divide the pie into 4 quarters and charge $10 per quarter. Now, I don’t know about you, but when I go to a bakery or a coffee shop for a piece of pie, I am not interested in shelling out $10 for 1/4th of a pie. I also don’t know of many places that will sell you a fractional piece of a menu item. So, the shop owner would do much better to slice the pie into 8ths or 16ths, and offer each piece for $5 or $2.50, respectively. The smaller, more affordable quantity is more appealing to the vast majority of people, but the overall value of the pie hasn’t changed – all the pieces together still add up to $40.
So it is with a stock split. Investor perception is that $20 to $80 is a reasonable price to pay for a share of stock, so sometimes companies will split the shares when the price has risen above these levels. In Berkshire’s case, the split was due in part to the acquisition of Burlington Northern Santa Fe. In order for Berkshire to be able to offer shares of BRK.B in exchange for shares of BNI, they had to reduce the share price. Why? If BNI is trading around $100, and you own 20 shares, your investment is worth $2000, which is less than BRK.B’s per-share price of $3500. In the same way that you can’t order half of a menu item, you can’t trade fractional shares of stock, only whole shares.
To sum up, I will quote John Ogg from 24/7wallst.com, “A split is technically a non-event on true fundamentals. But at this point it has finally become a stock that the public can own.” It’s the same pie, just divided into smaller pieces.
Sarah DerGarabedian, Research and Trading Associate