It’s easy to write off stock splits as a ploy aimed merely at attracting small-time retail investors who, it seems, would rather buy a parcel of 100 stocks of low denomination than 50 stocks of twice that denomination. Similarly, giving existing holders 200 shares, say, in place of the 100 they held before apparently really does make some of them, at least, feel better off. Even though the total cost and value remain the same.
But can this really be true? Surely it doesn’t take the wit of Einstein to see that doubling the number of shares a company has outstanding while halving their value is unlikely to leave holders of those stocks better off. But if this is self-evident, why on earth do so many US companies go through this process, with such regularity? By November, there had already been 752 splits this year – and still counting.
The short answer is that they believe it works – for investor relations purposes, at least. Proponents of stock splits say they can broaden and increase the universe of potential investors interested in buying a stock simply by reducing its unit value. In short, they say, splits increase both demand and liquidity – which between them make up a large part of what IR is all about.
But do the statistics bear this out? The answer, according to Richard Wines of Georgeson & Co in New York, is a resounding no. He’s spent some time analysing the data and has yet to be convinced that splits make any palpable difference to liquidity.
And even if retail investors do prefer stocks to be of lower denomination – say, under $50, rather than up towards the $100 mark or above – it’s hard to believe that this alone would persuade companies of the merits of splitting their stock.
After all, the market is increasingly dominated by institutional investors; and while retail equity holding may rank up there with motherhood and apple pie, in the absence of clear business benefits, that usually isn’t enough to make hard-headed cost-conscious companies pander to irrationality.
Moreover, with the fall-off in the proportion of retail holdings, even if these investors are galvanised into trading action by a stock split, that’s hardly likely to have an impact on a stock’s liquidity.
But if rationality is not the guiding light here, there must be something else prompting the rafts of US companies to go on announcing regular stock splits. ‘It’s cultural,’ says Wines, who notes that stock prices are apparently inflation-resistant, as he puts it. ‘The average stock price in the US hasn’t changed since the 1920s,’ he marvels. It was in the $20-30 range then, and remains the same today.
For some reason, companies have colluded with investors over the decades to keep stocks at roughly the same unit price, despite the fact that it costs those companies hard cash to do so – and despite the fact that the purchasers of everything else they sell have accepted massive increases in unit prices over the past seven decades.
It’s not just the high-flying, flavour-of-the-month Nasdaq stocks that go for splits, either. Splits by Nasdaq companies do outnumber those of NYSE and Amex companies by nearly two to one, with high-tech glamour stocks like Netscape and Cisco leading the way; but there are plenty of blue-chip splitters as well. Examples from this year’s roll call include Coca-Cola, Pepsico, Fannie Mae and Johnson & Johnson, to name just four.
Some companies have a clear policy of splitting their stocks whenever they have traded over a certain threshold level for a set period – three or six months, for example. Others keep the possibility of splits under regular review but have no fixed policy. Johnson & Johnson, which split two-for-one in June, comes into the latter category. ‘There’s no fixed corporate policy,’ confirms Annie Lo, assistant treasurer, investor relations at J&J. ‘But we have had several stock splits over the years. We do it because our individual investors like it.’
Indeed, this year’s split was J&J’s fifth in the last couple of decades, the first two of which were three-for-ones, the last three two-for-ones. This year’s, like others, came when the stock was trading at over $100 and its purpose was to get the price back around the $50 mark.
Jim Rapp, who manages investor relations at the Wilmington, Delaware-based chemicals company Hercules Inc, is more cool-headed about stock splits than many. His company split its stock three for one in January of 1995, when the price had climbed to $115-plus. By the middle of the year it was back up to around the $50 mark, where it remains today.
That sounds like a more than respectable price performance, but Rapp is hesitant about attributing any of Hercules’ success to its stock split. ‘The retail market is the only place where a split will have an impact,’ he confirms, noting that Hercules’ shares are 80 per cent owned by institutions.
‘But there is a feeling among average investors that stock prices rise after splits,’ says Rapp. ‘In fact, that’s often because the company announces an increased dividend at the same time as it announces the split. Personally, I don’t think splits do add value. But it’s a perceptual, even an emotional, thing for many investors.’
Rapp does not believe that meeting those emotional needs justifies the expense of a stock split, however, noting that there are serious costs involved in producing all the new stock certificates. ‘I’m inclined to agree with Warren Buffett – the leading proponent of not splitting stock,’ he says.
Why, then, did Hercules divide its shares into three last year? According to Rapp, it was in response to pressure from the company’s NYSE specialist. The shares had gone over the crucial $100 mark, he recalls, ‘And our specialist was screaming that it would improve our liquidity if we split the stock.’ Nearly two years on, however, nothing has happened to change Rapp’s original view. ‘I think the shares have traded a little less, if anything,’ he says.
Wines insists that the statistics support Rapp’s anecdotal evidence. ‘Using the standard technical measure of liquidity – the value of stock you can move for a 1 per cent movement in the price – you find that liquidity actually goes down a little following a stock split,’ he says.
Wines undertook a study of stock splits a few years back on behalf of the Nasdaq Stock Market, to try to get behind the perception to the hard facts. They indicated that splits did have a slight impact on liquidity, but typically that impact was negative.
There are two reasons for this, according to Wines. The first, more obvious, one is that retail investors nowadays make up such a small proportion of overall trading in most companies that even if their trading is boosted by a split, that makes little impression on a stock’s overall liquidity. And since retail ownership is contracting by about 1 per cent a year, its impact is likely to become even more insignificant.
The second reason is somewhat more technical. ‘In the US market, most quotations are in fractions – the bid/ask range will be, say, 301/8 – 303/8,’ Wines explains. ‘But if that stock is split, it won’t go to 153/16 – 155/16; the fractions will still be eighths.’ In other words, the spread gets wider when the stock price is lower, which is more likely to inhibit liquidity.
But whatever the statistics say, there seems little doubt that individual investors do like stock splits and that companies wanting to woo retail holders are willing to satisfy their desires. According to Scott Conyers, a Portland stock analyst, ‘People take splits as a bullish sign.’ Conyers has attended many companies’ annual meetings and reports, ‘You never hear louder applause than when a stock split is announced. Wealth is created in people’s minds.’
Anecdotal evidence from retail investors certainly bears this out. ‘I definitely believe they make the stock go up,’ one such investor told us. A young professional New Yorker, he is less interested in the stats, more interested in the number of shares he owns – as well as their value, of course. ‘I bought McDonald’s shares just after a stock split,’ he recalled. ‘They haven’t split again since then, but I wouldn’t have bought them at their pre-split price. I’d only have been able to buy 100; as it was I could buy 200. And since I bought those 200, they’ve gone up to the price they were before the split.’
This young man is a passionate fan of stock splits. He has no doubt that they push stock prices up and, as this issue of Investor Relations was about to go to press, he was thrilled by a recent announcement from CompUSA that it was to split its stock in early December. He could hardly believe his luck, since this was CompUSA’s third split since he bought its stock a little over two years ago, and the second this year.
Presumably our New York investor would have been in seventh heaven if he’d been a Monsanto stockholder earlier this year, when the giant chemicals company split its stock by no less than five-to-one. Monsanto announced a dividend increase – from $0.69 to $0.75 a quarter – at the same time, together with a new stock option plan and the resumption of a buy-back programme. Monsanto’s stock price, which had already doubled over the year running up to the original disclosure of its plans back in March, jumped by $63/8, to $1513/8 on the day it made the stock split announcement.
But was the investment community in fact ignoring the gimmickry of the stock split, while pushing the stock price higher purely in reaction to the buy-back and the dividend increase? A recent academic study by researchers at Rice University’s Jones Graduate School of Administration, in Houston, Texas, claimed to prove that stock splits are much more than cosmetic gimmicks. Their conclusions were based on a scrutiny of every stock split on the NYSE and the Amex between 1975 and 1990.
According to David Ikenberry of Rice University, one of the co-authors of the study, ‘The first five days after a stock split, the average price pop is 3.5 per cent.’ That’s the equivalent of about $1.75 in a $50 stock splitting two-for-one, he says.
That doesn’t seem surprising, but the researchers also found that split stocks go on outperforming the market for up to three years after the announcement of a split. In the first year the outperformance averaged nearly 8 per cent over the rest of the market; over the three full years the average compound return was more than 12 per cent above the market.
However, a moment’s reflection about cause and effect – with reference to the age-old chicken and egg conundrum – soon changes one’s immediate reaction to these figures. For the simple fact is that companies, however keen they are to please retail holders, only announce split stocks after a period of strong performance and when they are anticipating continued good performance. The former is clear, because the stock has already run up. The latter remains to be proved.
Ikenberry himself offers the analogy of a stock picker investing in a company that’s just split its stock to a diner opting to eat at a restaurant with long lines outside. The restaurant isn’t good because of the lines; the lines are there because of the quality of the food in the past – and the hope that the chef won’t be having an off day today.
Ikenberry’s not the only person who resorts to a food analogy to explain the mysterious motives behind companies’ continuing willingness to cut their stock pies into smaller slices and their shareholders’ ongoing appetite for them. ‘I liken doing a stock split to eating a chocolate bar,’ says Richard Wines. ‘It has no nutritional value, but it makes you feel good.’
More than that, for some managements – and some of their stockholders – stock splits seem to be as addictive as a Hershey’s bar is to a chocaholic.
