With Amazon continuing to generate massive revenues, particularly in web services that have seen growth of 64% year-on-year and has continued to maintain massive popularity among investors, its stock price has also been rising, making it more expensive. The current AMZN stock price, that is north of $1,100, has gotten to the point that regular, casual investors are unable to afford buying into the company.
Its initial forays into the realm of quadruple-digit stock prices have been the toast of the media, but one thing is becoming clear: It is now time for Amazon to do something it hasn’t since 1999 – split its stock. Even with the Dow rallying by 18% over the last year, the index’s median price for blue-chip stocks stands at just above $97. This makes Amazon’s stock price appear prohibitive to many people who would like to buy the company’s shares.
How an Amazon Stock Split Would Affect Investors
What is a stock split? For instance, if an investor owns 100 shares of a company trading at $80, which later has a 2-for-1 split, they then end up with 200 shares, each having a value of $40. However, the investment’s total value still remains at $8,000.
All being said, the main motivation for a company to have a stock split, in most circumstances, is so that the share price is maintained within a particular range. This not only keeps the shares affordable to small-scale retail investors, but also makes it possible for people to spend more of their money on the stock.
Let’s assume that you have $1,500 which you want to invest in the shares of Amazon.com, currently trading at about $1,176. At this price, you would only be able to afford one share of the company, leaving you with $324 uninvested.
Conversely, if Amazon were to affect a share split of 10 for 1, the price per share would drop to $117.60, with each share representing one-tenth of its current equity. What it also means is that your $1,500 will buy you 12 Amazon shares, leaving only $88 on the sidelines.
Psychological Appeal of a Lower Share Price
A share price is just a share price. Although this logic is completely true, we are human and not necessarily rational all the time. This especially holds true when it comes to prices. Think about how many things are priced at $0.99, $9.99, etc. When thinking rationally, nobody thinks that these prices are anything but one dollar or ten, that is being asked of us.
However, there is something in the back of all of our brains that overcomes this rational line of thought, and screams ‘Bargain!’ whenever we see a slightly lower price. This is what makes stocks more appealing psychologically after a split, since the lower price per share makes it appear to be a better deal.
In addition, announcements of a stock split have commonly been regarded by many investors and industry experts as a bullish sign. The conventional wisdom in the market is that no company would dare to split its stock and lower the price per share unless there was a immediate rise expected within the short term.
The Liquidity Factor
One of the key reasons why companies consider splitting their stock is a case of illiquidity. If a stock is traded infrequently, shows a reasonably large difference between its bid and ask prices, and has a low level of free float, it is considered to be illiquid.
That being said, there is little sign of illiquidity in the case of Amazon (AMZN) stock. This is because about 3.9 million shares of the company are traded daily, there is a free float of about 397 million shares available to the public and its bid-ask spread stands at less than $25, a similar level to the Bank of America (BAC).
So, although the problem of illiquidity is not necessarily an immediate concern for Amazon, a stock split still makes sense since it helps to prevent illiquidity from developing over the long term.
Public and Press Interest
Berkshire Hathaway (BRK.A), which is a holding company operated by Warren Buffet, provides a rather extreme example of what could happen when a highly successful company does not split its high-value stock. A Class A share in the company costs about $270,000. Because of this, there are very few shares of the company traded on a daily basis.
On average, its daily trading volume is 332, in comparison to 3.9 million for Amazon. Besides the liquidity concerns, such a low level of trading volume is likely to present a new problem which Amazon has never experienced before; reduced public interest and dwindling coverage in the press.
Berkshire Hathaway and Amazon both have similar market capitalizations, with each at about $450 billion. However, Berkshire does not receive anywhere near the press coverage that Amazon does. Why should it? By trading 332 shares per day, there are very few people who actually care what is happening with Class A Berkshire stock.
However, positive press coverage and public interest are especially valuable to Amazon, whose services cater to the masses and is a company that is constantly trying to build up a buzz about its products and services.
A Path into the Dow Jones Industrial Average
A very important reason for Amazon to seriously consider a share split is that it is the only way for the company to get itself listed on the Dow Jones Industrial Average. Getting in the Dow is not easy, since the benchmark has just 30 trend-setting companies. It is far different from the Nasdaq 100 or the S&P 500, both of which Amazon got into easily once the company grew big enough.
Because it is a price-weighted index, unlike the S&P 500 which is based on market capitalization, the Dow 30 is heavily influenced by the actual stock price. Amazon’s current stock price is higher than 15 of the benchmark’s lowest-priced components and over four times greater than the index’s second-largest stock. It is not possible for Amazon to get into the Dow index at its current price, since it would have more influence on the benchmark than half of its current members combined.
At this point, the Dow-worthiness of Amazon’s stock may be debatable, but it will happen at some point in the future. However, the stock will need to be significantly split to ensure that the addition of the tech giant does not destabilize the index.
Amazon has had its stock split before – in fact, three times – so this would hardly be new ground for the company. One share of the company in 1997 is now 12 shares, which means that, with the same rate of growth, the price of Amazon stock would now be 12 times higher than it is if it had never been touched. It is highly unlikely that there would be much investor interest or press coverage of Amazon if its stock was worth $14,000. This would also be bad for business.
It would appear that now is an ideal time for Amazon CEO Jeff Bezos to seriously think about splitting the company’s shares once again. When it is left unchecked, the kind of meteoric rise in stock price that Amazon enjoys may look cool, but it has some definite disadvantages, while a stock split offers some real benefits. Amazon needs to be one of the stocks that will split in 2018; the question is, will it be?