Key points:
- GameStop Jumped 10% as directors voted for a four for one stock split
- There's no direct reason why a stock split should benefit a stock price
- But they do, which is something we've got to accept as investors
GameStop (NYSE: GME) stock is up 10% premarket on the news that the company is to do a four for one stock split. Which does lead to the question, well, why do companies do stock splits? The answer being that, if the split is well executed, then the stock price rises as a result of having done the stock split. Which is, perhaps, a silly thing but it is a real one and that's what matters in investing and markets – reality.
GameStop is, of course, the first of the major meme stocks that we all enjoyed back in lockdown. Also, as more news is revealing, why RobinHood (NASDAQ: HOOD) almost tanked (they didn't have enough trade for the trade in GameStop that customers were doing as gamma blew out and therefore so did clearing house collateral requirements). There have been many attempts of repeats of the GameStop saga and only one – and this worked for very different reasons – that really did work was Hertz. For what really drove the GameStop stock price spiral was the short positions open in the company. It was a classic short squeeze, what made it different was that it was uncoordinated, coming off noticeboards like r/wallstreetbets.
That's all in the past though, GameStop is now well capitalised and working on its changed business plan. So, why would they do a stock split? Other than the obvious point that doing one seem to add 10% to the stock price, what's the justification behind the idea?
Also read: What Happened To Meme Stocks? .
As to why companies do stock splits it's purely a matter of fashion. In the American markets the “right” price for a stock price is in the $10 to $100 range. Below that is thought a little speculative, above that expensive, and when the price is in pennies you can even lose the quotation. So, when stock prices rise above $100 there's this idea that changing the nominal price will add value to the company. As has happened here at GameStop. The GME stock price was $117 and change, announce a four for one stock split and the price rises $11, or just under 10%, to $128 premarket.
In theory a stock split should make no difference to the market valuation – four times as many pieces of stock still adds up to the total ownership of the same company of the same value. But that's not how it actually does work – that it doesn't is simply a fashion among investors, that idea of the “right” range for a stock price.
That it is just fashion is easily shown too. For in London that same right range is taken to be £1 to £10. Which is why an American Depositary Receipt of of a London stock is normally 10 London shares to one ADR. That's the way of getting both prices, the share and the ADR, into the correct fashionable ranges for each market.
The GameStop stock split makes no difference at all to the company or its valuation by basic investment calculation methods. But it does in fact change the market capitalisation – just one of those things about human investors.