Why does Buffett believe that stock splits may reflect investors’ gains?

Warren Buffett has long argued against stock splits, because he believes they increase trading activity, invite short-term speculators, and decouple the stock price from the underlying trading value.

Splits were one step Berkshire Hathaway would never take in Buffett’s view, as these had proven to degrade the existing shareholder base and risked reversing “three decades of hard work” in building Berkshire’s base of rational, owner-minded shareholders.

Why does Buffett oppose stock splits?

Buffett has focused on investor behavior and frictional costs in his case against splits. they:

1. Increased stock turnover, and thus the so-called “twitching” of transaction costs;
2. Attract speculative buyers who focus on quote, not value; Therefore,
3. It leads to prices that deviate from the intrinsic value.

He thus concluded that there were no “compensating advantages” to Berkshire’s traditional Class A stock split.

Buffet’s broader goal is a market price that is rationally related to intrinsic value. This requires self-selection and long-term owners who think as business partners, not traders. He claims that lowering the number of shares in order to lower the sticker price attracts the wrong audience: “People who buy for non-value reasons are more likely to sell for non-value reasons.”

Two exceptions: Class B shares and a 50-for-1 split

However, Buffett has made two exceptions in Berkshire’s history that may muddy the waters when it comes to splits. The first was Berkshire’s creation of Class B Shares (BRK.B) in 1996 to combat the proliferation of high-fee Berkshire “clone” funds and to offer a lower-class way for real, long-term investors to invest in Berkshire.

He stressed that this aims to preserve the shareholder culture that helped him make his investment decisions. Class B at approximately 1/30 of A share (with reduced voting rights) is set to be advantageous, but still has a large enough entry ticket to keep out the purely speculative minded. Today, B shares trade at 1/1500 of the market price of A shares.

Second, in 2010, Berkshire executed a 50-for-1 split of Class B stock to complete the acquisition of Burlington Northern Santa Fe (BNSF). Berkshire’s regulatory filings clearly positioned the split as a means to facilitate the deal, not as a new position on stock splits.

What it means for investors

For investors, there are two takeaways.

1. Don’t mistake the sticker price for less value. A split doesn’t change the fundamentals of the business, but it can change the behavior around the stock. Buffett wants this behavior to be consistent with long-term fundamentals, not short-term trading motives.
2. Allowing entry without diluting the philosophy. The dual class structure allowed small investors to purchase Class B shares without diluting Class A shares. This enabled Berkshire to make strategic investments while maintaining the culture of its core investor base.

Bottom line

Buffett has been frank about the issue. A split would raise trading costs, reduce the number of shareholders, and encourage prices that are less tied to the intrinsic value of the business, he wrote. His approach has not changed over the years, even with Berkshire adding Class B shares and splitting them for specific acquisition purposes, while maintaining never split A shares.