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What is a stock split?

To begin, it may pay to define what a stock split is: A stock split is a simple mechanism that a listed company can employ to increase the number of issued shares while keeping its market capitalisation/ valuation the same.

There are a couple of reasons a company may elect to perform a stock split, the chief among them is to increase the liquidity (or accessibility/ tradability) of their stock.

 

What happens to my shares in a stock split?

The most popular stock split ratios are 2:1, 3:2, and 3:1. By way of example, if a hypothetical company were to perform a 3-for-1 stock split, its shareholders would be issued an additional two shares for every share they owned before the split. In conjunction with the split, the value of each share would be devalued to 1/3 of its pre-split value. Effectively, the total value of three shares after the stock split should be worth the same value as one share before the stock split.

What is a reverse stock split?

A reverse stock split is when a company reduces the number of shares available while keeping its market capitalisation/ valuation the same. A company cannot simply remove shares as easily as it can issue new shares. Therefore, with a reverse stock split, a company is forced to revoke all existing shares and issue new shares, proportional to the reduction that the company is pursuing.

A primary reason a company performs a reverse stock split is to avoid being delisted from its stock exchange which may have set minimum share-price conditions on its listees.

What are some famous stock splits and reverse stock splits?

Tesla (NASDAQ: TSLA) performed a 5:1 split of its stock in August 2020. At the time, TSLA shares were trading above US $1,300. Tesla CEO Elon Musk believed the EV Company’s shares were too expensive for retail investors, so he reduced its price via a stock split.

Microsoft (NASDAQ: MSFT) has been a serial stock splitter. Since listing on the Nasdaq in 1986, The Software Company has performed nine stock splits, the last occurring in 2003. Consequently, 100 MSFT shares in 1986 would now total approximately 30,000 shares.

The beleaguered General Electric (NYSE:GE) performed a 1:8 reverse stock split in July 2021. Before the reverse stock split, GE shares were teetering around US $12. The reverse stock split meant that GE shares began trading above US $100 per share, a threshold not crossed for a very long time.

Microsoft (NASDAQ: MSFT) announced on 15/09/2021 that it would spend US $60 billion buying its own stock. As of writing, MSFT is trading at US ~$300.00 per share, which means Microsoft will be buying approximately 200 million shares and removing them from public circulation. Indeed, 200 million is only 2% of the total 7.51 billion MSFT shares available. As such, immediately after the announcement on Wednesday, MSFT share price rose a corresponding percentage.

Microsoft is far from the only company that participates in stock buybacks. In fact, they have become a relatively common occurrence over the past decade and are increasing in popularity. Apple (NASDAQ: AAPL), Amazon (NASDAQ: AMZN), and Alphabet (NASDAQ: GOOGL) have all purchased back large swaths of their own stock in the past few years. Apple has been one of the most aggressive in this respect, buying shares of AAPL at a total cost of US $77 billion since 2019.

Why would a company buy back its own stock?

stock buyback index

Stock Buybacks Keeps Shareholder Happy

For one, stock buybacks allow companies an easy path to increase shareholder value. If a company is to invest the money in Research and Development, there is no guarantee that a new product or service will eventuate, improving the company's performance. Stock buybacks are a relatively risk-free method to keep shareholders happy.

Think of it this way: Imagine there are 1 million public shares of Company XYZ. Each share is currently worth US $1,000. In this example, Company XYZ would have a market capitalisation of US$1 billion (share price x total number of shares).

Company XYZ then proceeds to repurchase half the number of public shares via a share repurchase plan and removes them from general circulation (imagine that these shares are burnt and no longer exist). Consequently, there are now only 500,000 shares left to be traded or held by the public.

After this event, What will happen to the per-share price? The company's market capitalisation hasn't changed, as the business fundamentals are irrelevant to the share repurchase. The company should still be worth the same $1 billion value. Thus, each share should now be worth US $2,000, and shareholder value has increased 100%.

Increase Dividends < Stock Buybacks?

Buying back stock is a more straightforward and sustainable way to return value to investors than increasing dividend payments. Stock buybacks are more sustainable as there is no expectation for them to continue every quarter. Whereas a dividend payment, inflated in one quarter with cash on hand, may put a strain on cash reserves/flow in future quarters and ultimately putting off investors when the dividend is revised down.

Removing shares from circulation via share purchase plans also reduces the company's long-term cost of equity. Essentially, the fewer shares there are, the less money a company has to pay out in dividends moving forward.

Shattering The Altruistic Illusion Of Stock Buybacks

Stock buybacks are not just for the good of public shareholders. Many publicly listed companies' top brass benefit from the increased stock price value, directly and indirectly.

Directly, company directors and such will most likely hold stock or stock options of the company for which they work.

Indirectly, the remuneration received by some company executives can be determined by the increase or decrease of the company's stock price during their directorships. For example, Apple's CEO, Tim Cook was paid a bonus of US $750 million in August 2021, in part, for APPL shares rising 190% since mid-2018, while outperforming the S&P 500 index. The performance of AAPL certainly owes a great deal of gratitude to the more than US $77 billion in stock buybacks that Apple made over this time.

With Monday earning reports out of the way, it is now time to turn our attention to the reports due Tuesday. Interestingly, Half of FAANG are releasing earnings reports today. For this reason, expect a hyperactive NASDAQ during the Tuesday session.

Let's start with Apple Inc (NASDAQ: AAPL) and Microsoft (NASDAQ: MSFT)

The two largest companies in the US, APPL and MSFT, are reporting one after another on Tuesday.

The Market Analyst seated to the left of me, Pavan Sharma, from the equities research arm of BlackBull Markets (check them out for astute stock picks), shared the following interesting graphic from 2020 with me that demonstrates the enormity of Apple.

airpods

This graphic begs the question; how many Air pods did Apple sell in Q3 2021, and how much this device contributes to the Company's Q3 revenue?

Revenue for Apple is anticipated to be US $73B, up by more than US $10B over the PCP. Air pods might be a smaller portion of the Company's Q3 revenue depending on how well the iPhone 12 has sold in the quarter and whether Apple has experienced any Air pod supply constraints.

When it comes to Microsoft, investors will want to see if it has maintained its cloud service revenue growth. Cloud is now the software Company's most significant revenue stream and should hopefully account for more than US $14B of the US $44B expected revenue for the quarter. Microsoft's past success in cloud computing might be its downfall this quarter. Maintaining a 25% YoY growth in its cloud division is a big ask.

As an aside, BlackBull Markets research arm's top tech pick is Apple for several reasons. The main reason being its strong brand presence and ability to make healthy margins on its wide variety of products and services with strong growth potential anticipated on new products and services as well - particularly digital services complementary to its core business. Apple also has a solid balance sheet with ~$196 billion in cash, which can be deployed to reinvest in new offerings or acquisitions, and on traditional valuation metrics is more attractively priced than its mega-cap peers with a solid history of paying a growing dividend.

APPL and MFT earning reports will drop after the closing bell on Tuesday.

Mattel (NASDAQ: MAT) likely to surprise

Because I covered Hasbro (NASDAQ: HAS) yesterday, I want to cover Mattel, another big toymaker, today.

Mattel EPS

Mattel has made a habit of making pessimistic projections, whether underselling their projected profits or overselling their projected losses. For this reason, the Company's actual earnings-per-share are likely to surprise the market when Mattel releases its earnings report after Tuesday trading concludes.

Mattel's earnings for its Q2 operation is expected to be slightly above USD 900M, up 23% from the PCP when it was contending with the Covid-related closure of many of its retail partners.

Other earning reports to watch Tuesday:

IPO's – Hot or not?

"Initial Public Offerings" – or IPO for short, have been the most popular way for businesses to raise capital for their business. However, as of late, they have been used as an exit strategy for early venture capital investors. The question becomes – should you spend your hard-earned money on stocks that have recently IPO'd?

The purpose of an IPO have changed – however; you'll have to read between the lines to see it

Bill Gates, the founder of Microsoft, is one of the wealthiest people in the world. However, his IPO did not immediately send him into the stratospheric amounts of wealth he has today.
Microsoft took one round of venture capital funding and stated that they did not need the money – they wanted the investors. Come IPO, Bill Gates, Paul Allen, Steve Balmer, and the Venture Capitalist, David F Marquardt, sold 17% of their shares on the open market. They raised over USD 61 Million (Around $140 Million in 2020) for the company, and the company was worth around $780 Million. Since its IPO, Microsoft has never had an unprofitable quarter.

Contrast this with Lyft, whose initial public offering netted the company $2.34 Billion (yes, with a B), giving the ride-sharing company a valuation of $25 Billion. This was after being funded by over 72 VC Firms. The founder, John Zimmer, was an instant billionaire at the time. However, the S-1, a pre-IPO document that was filed, warned this as one of the key risks:

Around 18 months after their IPO and Lyft has yet to make a profit. From its IPO date to the start of 2020, shares were down approximately 44% from its IPO price.

Clearly, there are differences between the two IPO's. Microsoft was profitable and did not need the money to continue. Lyft was and still is not beneficial and needed the money to continue.

Given the fundamental reason for an IPO is to raise capital for the business, it wouldn't be wrong to assume Microsoft's IPO shouldn't have happened, and Lyft's IPO was warranted. However, Bill Gates did not want to IPO. He hated the idea of the IPO, stating that "the whole process looked like a pain" and that it's an "ongoing pain once you're public.".

Bill Gates, co founder, chairman and CEO of Microsoft in 1995: "hate the whole thing. All I’m thinking and dreaming about is selling software, not stock"

John Zimmer had no such quarrels. This begs the question, what is the real reason investors want to IPO?

Don't get me wrong. I'm not saying that realizing wealth through an IPO isn't a valid reason for doing one. However, it may be a sign for investors on the secondary market like you and me that the company's leadership and initial values may not have the same outlook for the company as me and you. They get rich on IPO. You buying their shares makes them rich.

IPO Price? You can forget it.

DoorDash' IPO Price of $102 does not even register as a price ever available on the secondary market

Today, Doordash, a business that delivers food similar to Uber Eats, IPO'd for $102. However, the price available to investors on the secondary market were upwards in the range of $180. We see these initial spikes just after the IPO on most IPO's these days. This begs the question, will the strategy "Buy at the IPO price then sell straight after" work?

Yes – however, you can forget trying to get the stock at the IPO price. Long story short, shares allocated at IPO are earmarked for early investors, and the investment banks underwriting the public offering. Chances are, you will get the IPO at the price once it has already spiked.

Not all unprofitable companies get the green light for the IPO

wework IPO did not work

One of the most spectacular IPO failures in the past couple of years was the office-sharing company WeWork. I recommend reading this article on Bloomberg Businessweek on why it failed. However, a quick summary is as follows

Microwave Schematic, or "The We Company's" corporate structure?

And many more. This may have been a spectacular failure with regards to WeWork eyeing out a $47 Billion valuation. However, this was a massive success regarding the market identifying what companies should and should not be in public investors' hands.

Not all IPO's are with unprofitable companies

A recent highlight in the IPO world was a company we all came to love during the lockdown. Zoom Video Communications generated a Net Profit before its IPO, indicating the company was in good standing before releasing their shares to the world.

IPO's can be lucrative for investors who are in before the hype. Chances are, once you think about investing in an IPO, it's too late. However, you may find the gem in the rough, such as Zoom or Beyond Meat, which continue to prosper post IPO. So IPO's. Hot or not? Let's say they're lukewarm.