Apple Stock Split: What It Means for Interested Investors

Source: Getty Images

On Wednesday afternoon, Apple (NASDAQ:AAPL), the world’s largest publicly traded company, reported its second-quarter earnings. The company announced 7 percent income growth, as well as a dividend hike and a stock split. In response, the shares soared 8 percent on Thursday.

While the income growth and the dividend hike are clearly positive developments, what about the stock split?

Stock splits are intriguing insofar as they theoretically have no bearing on a company’s fundamentals, and yet they are still considered to be a big deal. A company that has 1 billion shares outstanding worth $100 each is worth the same amount as a company with 2 billion shares outstanding worth $50 each. The important thing is not a company’s share price but its overall market valuation relative to the fundamental value of the underlying business.

At the same time, when a company splits its stock, it often makes the news. Furthermore, we often see some interesting price action before and after a stock split. There is an intrinsic belief that a stock will be more appealing after a split. It is psychologically more satisfying to own more shares of a company, even if they are worth less. Also, small investors feel like they are locked out of high-priced stocks such as Priceline (NASDAQ:PCLN) or Apple – they don’t want to call their brokers and ask for three shares of a stock, because it makes them sound unimportant.

However, this sort of thinking often creates demand for a stock prior to the split, as traders anticipate this increased demand coming from smaller investors. Therefore. we often see a stock rise into the split, and this is followed by a selloff.

Take, for instance, Mastercard (NYSE:MA), which recently split its stock 10 for 1, meaning that for every one share you used to own, you now own 10. In the weeks after the announcement of the stock split but prior to the actual split, the stock rose more than 10 percent. It was then followed by a correction from $83 per share to a low of $68 per share, and it now sits at around $74 per share, which is roughly where the stock traded prior to the split announcement.

We also see similar trading activity in Coca-Cola (NYSE:KO), which split its stock 2 for 1 in August 2012. The shares peaked for the year at more than $40 literally days before the split, and they closed the year 10 percent lower.

There is a possibility that we can see something similar in Apple stock. Apple is splitting its stock 7 for 1. This is going to bring the share price to about $81 per share, assuming the share price remains at $567. If the same pattern reoccurs, then we should see Apple stock rise into the actual split and then start to sell off just before it takes place.

Is this a good roadmap for traders? I actually think that it is. In addition to the pattern we observed with Mastercard and Coca-Cola, one can make the fundamental case for such trading activity in Apple shares. Apple reported relatively strong second-quarter numbers, and this should generate enthusiasm for the stock.

But at the same time, the company has failed to release a game-changing product since Steve Jobs died, and I think longer-term investors are concerned that the company can only ride the coattails of Jobs’ accomplishments for so long. They may see the strength in Apple shares as a selling opportunity. This is especially the case for investors who got in late and who want to minimize their losses.

With that being the case, I think now is a good time to own Apple shares for the short term. Anticipation of further growth, additional share repurchases, and anticipation of a stock split will likely generate near-term enthusiasm for Apple. But until the company begins to innovate again, I think it is unlikely that we will see a breach of the old highs, and strength in Apple should be sold going into the split.

Disclosure: Ben Kramer-Miller has no position in Apple or in any of the companies mentioned in this article.

More From Wall St. Cheat Sheet: