IT infrastructure company Super Micro Computer (NASDAQ: SMCI) has been a favorite among artificial intelligence (AI) investors over the last year.

Earlier this month, Supermicro reported financial results for its fourth quarter and full fiscal 2024 (ended June 30). The earnings report was a mixed bag, but management surprised investors by announcing a 10-for-1 stock split.

Let's explore how stock splits work and examples of recent ones from comparable AI businesses to help form a thorough investment thesis around Supermicro right now.

1. How do stock splits work?

Stock splits are simply a financial engineering mechanism.

When a company executes a split, its outstanding shares rise by the number in the split ratio (in the case of Supermicro, its share count will multiply by 10 following its 10-for-1 split). Conversely, the stock price of the company should subsequently decrease by the same factor.

For this reason, stock splits do not inherently change the market cap or valuation of a company. But as I'll detail below, news of splits often garner outsized attention, which can spur abnormal trading volatility for the stock in question.

2. Why is Supermicro splitting its stock?

AI has become all the rage in the technology sector over the last year and a half or so. Supermicro's close relationship with semiconductor darlings Nvidia and Advance Micro Devices has helped propel its business to a new level and cemented it as an emerging growth opportunity for AI enthusiasts. Since Jan. 2023, shares have risen by 652% as of this writing.

One of the primary reasons a company will split its stock is to make it more accessible. At over $615 per share, many investors likely perceive Supermicro as too expensive. If the 10-for-1 split were to occur today, the share price would drop to roughly $62.

Again, while you would technically be buying into Supermicro at the same valuation, investors could perceive the stock as less expensive and be more inclined to buy.

3. How are stock splits handled?

Brokerage firms such as Vanguard, Fidelity, or Charles Schwab handle the mechanics in the background.

Let's say you already own 10 shares of Supermicro at $500 per share. Following the split on Oct. 1, your brokerage account will automatically reflect your position as 100 shares purchased at $50 per share.

There is no work required on your end.

4. Has Supermicro ever split its stock before?

Supermicro's upcoming 10-for-1 split marks the first time the company will be splitting its stock.

5. Should you buy Supermicro stock before or after the split?

As I alluded to earlier, stock-split stocks can receive a lot of attention, which can affect share price dynamics.

For example, outsized momentum can affect a stock around the time of its split. As day traders pour into the stock, the share price often starts to rise rather quickly.

This activity can lead to significant valuation expansion in a short time, making the stock a riskier buy. I would encourage investors to be patient until momentum traders have exited and booked their quick profits. The last thing you want to do is buy a stock at a high valuation and be left a bag holder when traders suddenly sell out.

The chart above illustrates how Nvidia and Broadcom stocks moved around their own 10-for-1 splits earlier this year. Broadcom announced its split on June 12, Nvidia on May 22.

Investors can see that shortly after making these announcements, both Broadcom and Nvidia experienced fleeting jolts in their share prices.

However, both stocks have declined following the execution of their respective splits.

As a word of caution, I would not suggest hunting for a perfect moment to buy Supermicro. That said, recent examples highlight how buying too close to the split date could roll you up in higher than usual volatility.

A more prudent strategy might be to wait until after the split occurs and observe how the price action plays out. Should there be a sell-off immediately following the split, you might be able to buy in at a more reasonable valuation.

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Charles Schwab is an advertising partner of The Ascent, a Motley Fool company. Adam Spatacco has positions in Nvidia. The Motley Fool has positions in and recommends Advanced Micro Devices, Charles Schwab, and Nvidia. The Motley Fool recommends Broadcom and recommends the following options: short September 2024 $77.50 calls on Charles Schwab. The Motley Fool has a disclosure policy.

Here Are 5 Things Smart Investors Should Know About Super Micro Computer's 10-for-1 Stock Split was originally published by The Motley Fool