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John Reese is CEO of Validea.com and Validea Capital Management. Validea also runs its models through Validea.ca, a site focused on analyzing Canadian stocks through the strategies of legendary investors.

The new Tesla Gigafactory stands under construction near Berlin on August 31, 2020 near Gruenheide, Germany.

Sean Gallup/Getty Images

Tesla Inc. and Apple Inc. split their stocks on Monday, a move largely hailed as a way to draw in new investors.

At around US$2,200 and US$500 a share presplit, respectively, it’s pretty easy to explain why new, perhaps less experienced, investors would previously have been reluctant to jump in.

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It’s harder to take a chance on a high-priced stock. But at roughly US$442 (Tesla) and US$125 (Apple) a share, postsplit, the stocks would appeal to more people as a reasonable entry point. Indeed, the split shares in Tesla and Apple rose 15.1 per cent and 3.8 per cent, respectively, on Monday.

While business managers may welcome an influx of new investors, Lawrence Cunningham, a law professor at George Washington University, cautions that they may not be the best kind of shareholder: the ones who stick around for the long-term.

Stock splits tend to attract more transient owners, what Prof. Cunningham calls “low quality” shareholders.

Prof. Cunningham recently talked about the crossroads at which Tesla and Apple find themselves on Validea’s Excess Returns podcast.

The short story: Prof. Cunningham would have advised Tesla and Apple to think twice.

For sure, Tesla is in a sensitive position. Its eccentric chief executive, Elon Musk, has a devoted following both on social media and among Tesla’s shareholder base. Not long ago, he mused aloud about taking Tesla private. That never happened (and he got in trouble with the U.S. Securities and Exchange Commission over it), but that hasn’t stopped Tesla from making big strides.

The five-for-one split caps a spectacular 400-per-cent rally in Tesla shares this year. Four straight quarters of profit for the electric-vehicle maker puts it on track to be added to the S&P 500, which would be another major milestone.

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Being added to an index is a sign of stability that typically boosts a company’s share price and visibility.

What’s more, when a stock joins an index, the index-tracking funds have to pick it up. That opens ownership to passive investors, a growing subset of the shareholder universe. Problem is, while index investors are attractive long-term holders, they are what Prof. Cunningham calls low-conviction. That means their contribution to the company’s governance – the annual election of board members, ratification of company proposals and tax and accounting reports – isn’t the same as the vote of a shareholder who has taken the time to study the company and its management and has a vested interest in the company’s long-term success.

Apple, of course, is already in the indexes. In fact, as the most expensive stock among the 30 Dow Jones industrials, it has the most influence on the blue chips. But that will change after the split. Dow index stocks are weighted by price, and Apple’s new trading level will rank it below about 10 other components.

Not only that, the stock split could also attract more short-term investors such as day traders, a short-term cohort Prof. Cunningham also calls low-conviction.

What’s the ultimate prize if you are a manager? A high-conviction, long-term shareholder, Prof. Cunningham says, though obviously most companies will end up with a mix of each. These “high quality” shareholders are the best type of shareholder a company can have.

Warren Buffett’s Berkshire Hathaway Inc. represents both a company and an investor that operate on this model. From a company perspective, Berkshire’s class A share price of US$327,560 would scare away all but the most committed shareholder. There is a B-share option that trades at a more mortal $218.

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But Berkshire’s behaviour as a corporate citizen has attracted a stable and loyal shareholder base, Prof. Cunningham said, who has written numerous books on Mr. Buffett. Berkshire’s famous CEO communicates to investors infrequently, mainly through a widely read annual letter and through a raucous annual meeting that functions as part folk festival and part personal finance summit.

This puts the focus on the long term and takes the focus off the short term.

As an investor, Berkshire looks for this type of company, one that is focused on a long-term growth strategy based on a competitive advantage and stable fundamentals. The company’s US$240-billion investment portfolio has long-term stakes in financial companies such as Wells Fargo & Co. and American Express Co. that date back to the 1980s. Apple now makes up half the portfolio’s value after a buying spree in the stock that began in 2016.

There have been some mistakes, as Mr. Buffett has admitted, notably an investment in International Business Machines Corp., and some ill-timed bets, such as Berkshire’s fairly recent embrace of airlines that was abandoned this year after the pandemic hit the industry’s prospects.

The rise of passive investing along with the renewed interest in short-term stock trading via popular apps such as Robinhood and others reduces the pool of these high-quality shareholders, but that shrinking pool could also be the very thing that produces the long-term alpha for those who remain. Investors who have conviction, a long-term mindset and holding period, and who display investing discipline, may be the ones positioned the best to win over time.

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