Nvidia Just Announced a Stock Split. History Says This Is What Happens Next.
Nvidia (NASDAQ: NVDA) was already the hottest stock on the market, but investor interest in the AI chip leader is reaching a fever pitch ahead of its 10-for-1 stock split, which is set to take effect after the markets close June 7. The first post-split trading day will then be June 10.
Nvidia already delivered blockbuster returns for investors who bought the stock early in the generative AI cycle. Since the start of 2023, it has jumped nearly 700%, and some investors believe the stock split could fuel even more gains.
Is there evidence that stock splits are positive triggers for share prices? Let's see what history has to say about that -- but first, let's review the basics of a stock split.
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What is a stock split and how does it affect investors?
A stock split occurs when individual shares are divided into more shares that are worth proportionally less. For example, in a 2-for-1 split, the number of shares an investor holds would double, but the price of those shares would be cut in half. In the case of Nvidia's 10-for-1 split, investors will own 10 times the number of shares they did previously, but each of those shares will be worth 10% of what they were before the split.
It's important for investors to recognize that stock splits don't change the fundamentals of the business or a stock in any way -- like, say, a dividend would. A split does lower the nominal price of a stock, making individual shares cheaper, but it doesn't affect the valuation since it also reduces earnings per share by the same percentage.
Do stock splits lead to outperformance?
While splits don't change a company's fundamentals, there is at least some evidence that they are correlated with outperformance.
According to a frequently cited study from Bank of America, stocks that split their shares historically returned an average of 25% over the 12 months after the split is announced, compared to just a 12% total return for the S&P 500.
It's worth noting that stock splits historically correlate with bull markets. That makes sense since prices need to go up in order for a company to decide to split its shares.
During the dot-com era, splits were rampant, and any that were announced in the year before the bubble started to collapse in March of 2000 would have likely helped drive the overall outperformance in BofA's research.
However, the bank's research team said that the edge from stock splits persisted even in more challenging markets such as the 2000s, which included both the dot-com bubble bursting and the housing bubble popping, leading to the financial crisis.
There was also a high degree of variability among the results of the stocks that were split. For example, 30% of companies that announced splits fell over the following year, meaning that a split is far from a guarantee of outperformance.
Among Nvidia's "Magnificent Seven" peers, results have also been underwhelming following their recent splits despite the generally strong results of these same stocks:
Apple did a 4-for-1 split on Aug. 28, 2020. Over the next year, the stock returned 20% but underperformed the S&P 500's total return of 30%.
Amazon executed a 20-for-1 split on June 6, 2022, but its stock gained just 2% over the next year, compared to a 6% gain for the S&P 500.
Alphabet followed Amazon with its own 20-for-1 stock split on July 15, 2022, but also underperformed the S&P 500 over the next year, rising 12% compared to a total return of 19% for the broad-market index.
Tesla split 3-for-1 on Aug. 25, 2022, but fell 19% over the next year while the S&P 500 gained 7%.
Should you buy Nvidia because of the split?
Despite BofA's findings, buying a stock only because of an upcoming split is generally not a good idea, as the recent underperformance of the four stocks above helps illustrate.
Other factors like a business' competitive advantages, valuation, and growth opportunities are more important to evaluate than the stock split itself.
But splits tend to emerge at a point of strength rather than weakness, and that seems to apply to Nvidia right now. The company is reporting blockbuster growth in revenue and profit and remains ahead of the competition in the fast-growing market for AI GPUs and related hardware.
The stock split might be a nice bonus for investors, but the real reason to buy Nvidia stock is its dominance in generative AI hardware, and its growth potential as the AI market continues to develop.
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Bank of America is an advertising partner of The Ascent, a Motley Fool company. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jeremy Bowman has positions in Amazon and Bank of America. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Bank of America, Nvidia, and Tesla. The Motley Fool has a disclosure policy.
