Bacteria do it, atoms do it. And lots of shares do it as well. When they get too big, they split. But while it makes definite sense for microbes, the rationale is not so clear for stocks. When the CEO announces a stock split at the annual meeting, the retail holders may cheer, but that attitude is as rational as mine was when I used to exchange the banknotes in my piggy bank for pennies so that it would look fuller. And I was young and foolish then.
There are significant costs involved in splits: proxies and announcements to be sent out, certificates to be reissued and meetings to be held. Even so, many IROs are agnostic about the benefits – even as they announce more stock splits themselves.
There are newsletters and internet bulletin boards out there playing on the credulity of retail investors who think that buying stocks that are about to split will give them returns. But the evidence for that is lacking as well.
In the end, IROs invoke the magic word psychology – not one of the more exact sciences. The AES Corporation, the international power company which went two for one last year, typifies the general formula. ‘We begin to think about it when the stock goes over $70, which has been about every three years,’ says IRO Sandra Ross. ‘We’re a growth stock, and we want to make it easy for the retail investors, since they prefer it that way.’
Since power stations are big-ticket items, one would not expect its shareholders to be so picky. But then neither would Tiffany’s customers accept a diamond sawn in two halves as any enhancement of value. However, IRO Mark Aaron reports after their recent split, ‘Investors love it! Especially individual investors. Some will say that they won’t buy 50 shares at $60 but will buy 100 of the same stock at $30; they love to get that stock certificate or their brokerage certificate in the mail.’
Formula none
So do they get any benefit? ‘I haven’t really found it,’ admits Aaron. ‘We split two for one last year and announced it for this year, both times at our annual meeting, and each time the stock popped up a couple of points, but by the end of the day it was down.’
‘We don’t have a formula, but historically, we split our stock when it’s in the $60s or $70s, sometimes when it’s close to $100. We don’t want it to go too high because individual holders think that it may be too expensive,’ Aaron comments. Obviously stock buying and jewelry buying use different portions of the brain. ‘But I think that most people realize that if the stock is going to go up over time, it’s because the company is good – and hopefully the market is good as well.’
One tangible argument for splits in the past was that brokerage commissions on odd-lots of shares were a barrier to small investors in the States, but with reduced commissions that is no longer the case. However, in Japan it is still a potent effect.
Sony’s Yas Hasegawa had watched with equanimity as its stock approached $300 this year. ‘The stock split is not very popular in Japan, ‘ he explains, but in the end, in May, Sony split two for one, mainly because of local factors. ‘In Japan, most companies’ stock trades in minimum units of 1,000, and even though Sony had a minimum of only 100, that is a serious barrier – $30,000 for one unit!’
‘So the biggest reason is to increase individual shareholders, and while in the case of the US ADRs it is not a very potent effect, it is psychologically easier, in comparison with other companies.’ Hasegawa also cites psychology: ‘A $300 share is more difficult to get to $600 than $100 to $200.’
Soaring high
Nokia went even better. As its stock soared into the $200s the company split four for one. Audrey McGinnis, the IR manager, knows exactly why: ‘We really looked at this from the position of increasing our individual holders, since our institutional holders have a completely different mind set. In the past we’d been a lot more weighted on the institutional side, and my job when I came on board was to increase our retail holdings and to focus on the brokers and the individual holders. We have a very loyal consumer base as well as a very loyal investor base, so our idea was why not bring them together? Investors are more likely to own our product, and product owners are more likely to invest in the stock.’
‘When I joined the stock was only at $75 and people thought that was a bit high,’ McGinnis continues. ‘Now, three years later, their cost basis is again in the low double digits.’ However she is aware of the risks. ‘There’s always a thought that it’s going to run up after it splits, so that can add some volatility depending on who’s buying. But, being a technology stock, there’s so much room for volatility anyway, what’s one more cause?’
She agrees that the process can cost, not least because under Finnish law a split needs a full meeting of shareholders. ‘That’s why we do it around the annual meeting so that all the printing is already being done – we just add an extra line.’
In the end, most companies split their stock to please retail investors (except of course Berkshire Hathaway!), but really cannot refute Warren Buffet’s scorn at the lack of proven effects for the tactic. Tending to support him, Charles Kaplan, president of Equity Analytics, has read all there is to read about splits.
‘The four most common reasons cited by companies in deciding to split their stock are: to bring the stock back into an acceptable trading range; to increase the number of shareholders; to increase the float; to increase liquidity. Both volatility and volume increase subsequent to the split. However, contrary to what most corporate managers believe, liquidity actually decreases after a stock split,’ he insists, quoting intensive academic studies over decades.
The one exception he has found to the rule that splits offer little benefit to investors is where companies split stocks as a dividend, and account for them out of retained earnings. This produces an abnormal excess return – some 6 percent for about twelve months before the effect disappears.
‘Another reason is signaling theory, adds Kaplan.’ A management that splits its stock two for one is showing that it’s pretty confident its earnings are going to meet analysts’ expectations going forward.’ But don’t get clever and try to boost your stock by sending false signals. ‘Bad firms trying to mimic good firms get punished badly. If they miss a quarter after a split then they really get hammered.’
Looking back
Of course, bull markets are much more likely to make splits habit forming, as the last decade indicates. Kaplan points out that in 1930, at least 150 of the 837 stocks listed on NYSE had split in the previous decade, although the habit was somewhat broken by the events of 1929. He points out that ‘companies regaining their old highs after a split is a recent aberration. It’s not what typically happened.’
Conversely, First Call’s resident sage, Chuck Hill, remembers that in the 1960s IBM stock was trading in the $600 range – when that was a much more awe inspiring sum than today. ‘You do get a little pop when you announce a split, but other than a vote of confidence by the company in its earnings outlook, it just gives you two pieces of paper instead of one. A split doesn’t give anyone more value for it.’
In fact, Hill echoes Kaplan’s warnings that while a split is unlikely to bring much in the way of tangible benefits, there is a heavy price to pay for getting it wrong. ‘Usually no-one is going to split their stock unless they expect earnings growth, because if they split and their earnings don’t grow, then their price is going to go down to levels that are not psychologically good. There is a kind of a taint if your stock gets down to single digits. There shouldn’t be, but there is.’
David Tice, an independent – and bearish – analyst, is expecting a lot of just such discomfort. ‘It’s a disaster! Companies don’t realize that their stock can go down as fast as it goes up. And if they split to $30 it only takes a 60-70 percent drop to get them under ten. And there will be a lot of them.’
He adds, ‘All these services out there posting when splits will take place! I do a retail chat show and I get people asking, When’s the stock gonna split? It’s ridiculous. It’s a sign of the mania out there, the illogical nature of the market. Eventually it’s going to lead to a lot of single digit stocks and reverse splits don’t work very well.’
A web search for reverse splits, usually one for ten, reveals firstly that they tend to be last ditch attempts to rescue stocks about to hit penny stock status; and secondly that the attempt generally fails. Within a few years of such a move companies are no longer around as independent entities, with only their ghost web references around to bolster Tice’s apocalyptic warnings. The lesson? Think before you fission!
