Alphabet Stock Split: A Win for Retail Investors … And the Dow?

Google parent Alphabet (GOOGL, $2,752.88) briefly added more than $180 billion in market value at the opening bell Wednesday after the search giant easily topped fourth-quarter estimates … and delivered on many investors' longtime wishes by announcing a 20-for-1 stock split.

An Alphabet stock split would not only make its A-class GOOGL shares and C-class GOOG shares more accessible to retail investors, but also perhaps open the door for inclusion into the elite Dow Jones Industrial Average one day.

Alphabet announced both the stock split and its quarterly results late Tuesday, resulting in a jump in GOOGL stock of as much as 10% in the first few minutes of Wednesday's session. That's the biggest opening gap-up on earnings for its shares since April 2008, when they popped 19.1%, according to data from Bespoke Investment Group.

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As good as Alphabet's quarterly results were – it earned $30.69 per share on $75.3 billion in revenues, topping respective estimates for $27.34 per share on $72.3 billion – Wednesday's price action was likely driven every bit as much by news of its proposed share split.

The Alphabet Stock Split Explained

The communication services behemoth intends to issue 20 shares for each share held of its Class A, Class B and Class C stock (subject to shareholder approval, of course) after the close of business on July 15.

Now, stock splits are meaningless on a fundamental basis. A company's operations and prospects remain the same. In this particular case, the Google stock split is the equivalent of making change: Shareholders hand Alphabet a $20 bill and get 20 one-dollar bills in return.

But markets love splits all the same, and that seems to be the case yet again with Alphabet's share split.

And, to be fair, there are some technical reasons why this 20-for-1 split could give GOOGL stock a tailwind.

Alphabet closed Tuesday's trade around $2,750 per share. Post-split, that comes to about $138 per share. Although brokerages already offer customers the option of buying and selling fractional shares for free, the split should theoretically make GOOGL more popular with retail investors currently put off by the four-figure share price.

Looking farther out, it also makes Alphabet available for inclusion in the Dow Jones Industrial Average.

Google in the Dow? Maybe, But …

The blue-chip barometer isn't built like the other two major indexes, and that's what makes Alphabet's stock split so important.

The S&P 500 and Nasdaq Composite are weighted by market capitalization: the stock price multiplied by the number of shares outstanding. The Dow, however, is weighted by price. (If that seems weird, just know that the original 12 stock Dow was created in 1896 by Charles Dow, and the guy had to calculate the average every day by hand.)

One issue with the Dow's price-weighted construction is that it shuts out any stock trading at GOOGL's current lofty level. At $2,700 a share, Alphabet's stock would skew the average into meaninglessness.

UnitedHealth Group (UNH, $468.41), at roughly $475 a share, holds the greatest weight in the average today. Adding Alphabet at $3,000 would turn the Dow into the "Google and 29 Other Stocks Average."

Also know that it's up to the Dow's editors at S&P Dow Jones Indices on whether to add it to the average. That's not a simple decision. Alphabet is a member of the market's communication services sector. The Dow has two components from that sector already: Verizon (VZ, $53.20) and Walt Disney (DIS, $144.49).

Does one of those stocks then get the boot? VZ is the only telecom in the blue-chip average. DIS is the only media and entertainment conglomerate. The editors construct the Dow to reflect the broader economy. Shouldn't the Dow have a telco and a media giant?

And then there's the weighting problem again. If Alphabet (at around $140) replaced Verizon (more than $50), the communications sector's weight in the Dow would rise significantly.

The editors aren't bound by some rule that requires them to swap stocks within sectors. International Business Machines (IBM, $135.53) hasn't impressed anyone for going on a decade now. Pulling Big Blue and replacing it with Google might not be a bad idea. Their respective share prices would be roughly in line with each other after Alphabet's stock split.

Still, by strict definition, such a move would lift the communications sector's weight in the average at the expense of the tech sector. It's something the Dow editors would have to think about.

A Small Impact on the Market

Lastly, it's important to know that getting tapped for the Dow is largely symbolic.

When a stock is included in the S&P 500, its shares rise because a total of $13.5 trillion is indexed or benchmarked to the most widely used gauge of U.S. equity performance. Passive funds tracking the S&P 500 must own all of its components, weighted by market value. There's no way around it.

The Dow Jones Industrial Average, by comparison, is a dud in this regard. True, the blue-chip barometer can't be beat for brand familiarity. When regular folks talk about what the market's been up to lately, they usually mean the Dow.

But where the S&P 500 leads tens of trillions of dollars by the nose, only $36.6 billion is indexed or benchmarked to the Dow. Mega-cap stock GOOGL, by itself, is worth roughly 53 times all the money tracking and chasing the industrial average.

Sure, it would be neat if Alphabet became a Dow stock, and perhaps fitting too. But that's all speculative.

What we do know about the Alphabet stock split is that it should bring in legions of retail investors, possibly adding a tailwind – for a time – to the share price. Volume would increase … but then so too would volatility.

So be careful what you wish for.