The Ultimate Numerator-Denominator Bias


Would you like the pizza cut into eight or twelve slices?
I’m very hungry today, so better cut twelve slices.

Two big companies announced a stock split this month. Apple announced a 4 for 1 stock split, while Tesla announced 5 for 1.

This means that your 1 pizza pie is sliced into 4 slices and 5 slices for Apple and Tesla, respectively. You still have the same amount of pizza.

Apple was trading at $400 when they announced the split. After the split, Apple stock would trade at $100. At the same time, Tesla was trading at some $1300, and after the 5 for 1 split, it will trade around $260. The split in no way affects the market cap of the company. The amount of pizza has not changed; it’s just smaller and with more number of slices.

This simple logic seems to have eluded market participants.

Apple has surged 35% since the announcement, and Tesla has risen a whopping 85%.

One primary reason behind this increase is that the stock has become cheap and affordable for retail investors.

I don’t think that reason holds much water, especially in 2020, when fractional shares are everywhere. You don’t need to wait for a stock split to buy 1 share; most online brokers offer fractional shares where you can buy $5 worth of stock in any company. In other words, I can own 0.01 shares in AAPL if I want to; it does not matter what it’s currently trading at.

Not buying Tesla at $1300 because it’s expensive and buying it at $260 a week later because it is cheap now is a fallacy. The fundamental value of the company has not changed a bit. This is one time where $1300 is actually equal to $260.