GameStop's Stock Split: A Faithful Buying Signal or a Doubtful Maintainance?

GameStop Corp. is doing a four-for-one stock split in the form of a dividend that mimics the trend that has become more popular over recent years .

Apple, Tesla, and Amazon have also split their stock recently to attract new investors.

GameStop first indicated its plan to split the stock in March 2022, causing a temporary 22% spike in overnight trading to $203.98. Yesterday the stock closed at $117.43.Will today’s rally prove ephemeral as well?

This raises another important question, and that is whether investors should view stock splits as a bullish factor for buying a stock in the first place?

A Case Against Stock Splits

Most professional investors don't like the idea of a company splitting its stock. Some believe that management uses it as a trick to attract unsophisticated retail investors into supporting the stock.

In March, GameStop said the split would "allow for future corporate flexibility," which is a way of saying that we don't know what it will do.

The main reason to be doubtful of stock splits is that they do not alter your proportional ownership of the company. For example, if a stock is priced at $100 per share and there are one million shares outstanding, the company would have a market capitalization value of $100 million.

If the same hypothetical company decides to issue four times as many shares, the stock price would fall to $25 and there would be four million shares outstanding. As a result, after the "split" the company is still worth $100 million, and your proportionate ownership remains unchanged. The only difference is that you now own four times as many shares at a lower price.

It's clear that the whole thing is a bit of a joke.

In 2022, the meme stock craze that gripped markets following the pandemic is no longer working. Thus, today's news could be seen as a desperate attempt by management to stall GameStop's decline.

The following are reasons for stock splits:

After a stock split, investors who are bullish on the company's prospects usually see an increase in their investment. This is because companies that have done splits in the past have generally performed better than those that did not.

Since 1980, the S&P 500 index has seen 1,461 companies split their stock. That group of stocks has performed better than average over multiple time periods.

If stock splits are just a hollow exercise of manipulating numbers to artificially increase the price of a stock, how do we explain the fact that companies that do them have averaged more than double the market's return two years later?

When I started writing this piece, I thought that stock splits were not a good investment strategy. My analyst's research proved me wrong.

Perhaps stock splits succeed because they actually do make it easier for everyday investors to purchase shares?

One theory is that stock splits do not have a positive effect on share prices.

For example, it's possible that this will lead you into a basket of companies with strong momentum, which has been well documented as an alpha factor in academic studies. Stocks usually split after they've been performing well and the share price has risen, doesn't it?

If you liked GameStop's investment merits before the split, you can be even more bullish now that you know that most companies that do splits subsequently outperform.