The stock market is arguably the greatest source of long-term wealth creation. Inclusive of dividend reinvestment, the stock market has risen by an average of 7% annually, which works out to a near doubling in value every decade. In other words, if you remain committed to investing in high-quality stocks for an extended period of time, you should do just fine and wind up with a healthy nest egg to lean on in retirement.
Stock splits 101
However, the tendency of stock prices to rise over time can have an interesting psychological effect on investors -- it makes them think a company is more expensive. A lower stock price allows investors to buy more shares of a company, whereas a higher stock price, which nets fewer shares purchased, may turn investors off.
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Another issue with a high share price is that it could dissuade investors with small account balances from buying in. Unless they're using a service like Capitol One Investing, which allows for fractional share purchases for automatic investment accounts (those that invest a specified amount weekly, bi-weekly, monthly, or quarterly), an investor with $500 or less may have no means of buying into a stock currently trading at $600 a share, $1,000 a share, or higher.
To counter this psychological effect, most publicly traded companies that have witnessed their share price appreciate significantly will choose to enact a stock split. A stock split reduces the share price of a company by a factor chosen by its board of directors, and simultaneously increases the number of shares outstanding by that same factor. This results in absolutely no change in the market value of the company, but it's usually viewed with optimism by investors. Plus, a post-split lower share price has a tendency to make investors irrationally believe a stock is now "cheap" or "affordable."
As an example, if a stock with 1 million outstanding shares and a $100 share price split 4-for-1, it would have 4 million shares outstanding (four times as many as before) and a $25 share price (a fourth of what it was before). The value of the company remains exactly the same, but the lower share price and the psychological impact of being able to own more shares tends to have bullish implications.
Three stocks that really should split
Right now, there are hundreds of stocks with share prices north of $100. Here are three that would probably benefit from increased investment if they chose to split.
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The Priceline Group -- $1,809 a share
Though its stock absolutely plummeted during the dot-com bubble, The Priceline Group (BKNG -1.31%) has staged one of the most amazing comebacks for a company that underwent a 1-for-6 reverse split in 2003 (227 million shares were turned into 37.5 million, with its share price rising by a factor of six). Shares are up more than 260% since their debut in 1999, and more than 2,700% over the trailing 10-year period. Now could be the perfect time to reward Wall Street's patience with a stock split.
Priceline Group has a really good chance of continuing to head higher because of its advantages within the online travel booking space. Though it's locked into a competitive battle with Expedia, Priceline has a clear lead in terms of total members and international bookings. Expedia isn't sitting on its laurels, with both it and Priceline actively acquiring new booking businesses and expanding into foreign markets, but Expedia is clearly playing second fiddle to Priceline. This means hotel, airline, and auto rental companies flock to Priceline first, since it has the largest member base and the most diverse travel booking portfolio.
The company's first-quarter results also signal the likelihood that strong growth will continue for the foreseeable future. Hotel room nights booked rocketed 27.4% higher on a year-over-year basis, with rental car days also increasing by 15.4%. Further, gross travel bookings rose by 27% on a constant currency basis.
Its $1,809 per share price tag could be an impediment for investors who aren't able to buy fractional shares, though, meaning a stock split could open the door to new investors and even more optimism.
Image source: Intuitive Surgical.
Intuitive Surgical -- $899 a share
Few companies in the healthcare sector have been more rock-solid this century than Intuitive Surgical (ISRG -1.93%). Shares of the robotic-assisted surgical system developer have risen by nearly 4,700% since June 2000. But during that timeframe the company underwent only one split -- a reverse 1-for-2 stock split -- in June 2003, shortly after the dot-com and genomics bubbles. This Fool strongly believes that a stock split would be a means to attract even more investors.
As we look ahead, Intuitive Surgical's clear competitive advantage in soft-tissue surgeries should allow it to retain massive robotic-assisted market share. The company had more than 3,900 installed da Vinci surgical systems as of the end of 2016, which is far more than its peers have combined! It takes a lot of time and money to train surgeons and build the machines they'll be using, which means, based on rapport alone, Intuitive Surgical has a seemingly insurmountable lead over its peers.
The real advantage here is its razor-and-blades business model. Intuitive Surgical's surgical systems may run around $1.5 million each, but they're relatively low-margin for the company. The bread-and-butter high margins come into play when hospitals purchase instruments for each procedure and need servicing of their machines. As Intuitive Surgical's base of da Vinci systems grows, so should its margins.
With a bright future ahead, Intuitive Surgical would likely attract a number of new investors with a stock split.
Image source: Chipotle Mexican Grill.
Chipotle Mexican Grill -- $456 a share
A final company that would probably benefit from a stock split is fast-casual restaurant chain Chipotle Mexican Grill (CMG -0.71%). Shares of Chipotle have risen by nearly 860% since its public offering in 2006, and the company has never undergone a stock split.
Whereas Priceline and Intuitive Surgical should be considering splits to make their shares more affordable for those with less to invest, Chipotle's reason for consideration is that it could induce shareholder optimism associated with a stock split. Chipotle has run into some serious issues of late, most of which are tied to its multiple e. coli outbreaks, which tarnished the public's trust in the chain. In two years, Chipotle dropped from first to worst in Brand Keys' Customer Loyalty and Engagement Index for fast-casual restaurants.
Thankfully for investors, things are beginning to turn around. Chipotle has implemented new food safety standards, and the E. coli scare is beginning to be pushed into the rearview mirror. If consumers have shown anything over time, it's that they have a short-term memory when it comes to food scares. Chipotle's efforts to stick with as many locally grown, fresh ingredients as possible is allowing it to continue to differentiate itself from its competition. Considering that sales grew 28% during the first quarter and comparable-restaurant sales jumped almost 18%, I'd opine that Chipotle is starting to get back on track. A stock split could be the impetus that signifies to Wall Street that all is once again well with the company.
