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