Investors should focus on the company behind the stock and invest in undervalued high-quality businesses. According to the legendary investor Peter Lynch, “This is one of the keys to successful investing: focus on the companies, not on the stocks.” However, a new investing trend is emerging. When companies receive more attention from the general public, it generates “noise”, it’s discussed more, and its share price increases. Tesla’s share price movement in the last month is a good example.
Tesla Share Split Effect
On 11th August, Tesla released their earnings result and achieved the fourth consecutive profitable quarter, meeting the criteria to join the S&P500 index. At the same time, the company made another unbelievable announcement, a 1 for 5 share split. Each Tesla share will be split into five shares on 31st August. Since announcing the stock split on August 11, Tesla’s share price has skyrocketed 60%. It now trades at nearly $2,400 a share. How does the share split announcement boost the share price? And does it make sense that the value of a company rises by 60% because of that?
Theoretically, when a company splits their stock, the number of shares outstanding increases by a multiple (in this case, five), the total dollar value of shares remains the same compared to pre-split amounts because the split does not change the operation of the underlying company. For example, 1 Tesla share is worth $2,000. After the stock split, you will have 5 Tesla shares, each share worth $400. So why does the market react so positively to Tesla’s stock split? Because it is widely believed that a stock split increases the share’s liquidity. If an investor only has $800 to invest, he cannot invest in the company because the share price is $2,000. After a stock split, he can now purchase 2 shares. With the technological advancements to online trading in the United States, traders and investors are now able to trade fractions of stocks with no extra costs. An investor can purchase 0.4 shares of Tesla. In other words, the stock split does not provide much benefit to traders or investors with little capital.
The Self-Fulfilling Prophecy
If the share split effect is not the cause of Tesla’s recent bull run, what has bumped up Tesla’s share price? It can only be explained by the Self-Fulfilling Prophecy phenomenon. When Tesla announced the share split, the media reported and explained the share split effect. The general public believed that the share split will boost the share price because of the rise in liquidity. Therefore, the expectation of the rise in liquidity, rather than the demand created by rising liquidity pushed Tesla’s share price.
With the current increase in retail trading and easy access to information, the share market is more likely to be affected by the self-fulfilling prophecy. Investors should be more careful in their investment thesis and not being fooled by the share price movement. This is a recipe for disaster!!
Till next week happy investing.
Michael and Kenny