Stock Splits: Your Road To Riches?Anne Tergesen
eBay did it, and its stock took off, soaring 37% in a single day. The same trick worked like magic for Microsoft, Wal-Mart, and America Online, each of which instantly added more than $4 billion to its market capitalization.
What hot new products or organizational changes ignited those gains? There weren't any. The companies simply announced plans to split their stock. Like exchanging four quarters for a dollar, dividing one share of stock in two is purely a cosmetic act: Microsoft closed at $178 the day before its Mar. 29 two-for-one split. At that point, 10 shares became 20, each worth $89. The things that determine Microsoft's value--profits, sales, cash flow, and the like--remained unchanged.
Still, there is a reason why a stock split can light a fire under a company's share price. "It's a signal that management is optimistic," says David Ikenberry, a finance professor at Rice University. If a stock is trading above $45, where Ikenberry has found individual investors begin to curtail purchases, a board of directors that anticipates further gains might opt for a split. In a study of more than 1,200 two-for-one stock splits by New York Stock Exchange and American Stock Exchange companies between 1975 and 1990, Ikenberry found that stocks gain an average of 3.5% on the day a split is announced. In the year following the split, the companies beat peers by an average of eight percentage points--a trend that continued through 1996, he says.
Increasingly, individual investors are treating stock splits like get-rich-quick schemes. Some are spending as much as $1,000 a year for beeper services that broadcast news of splits. Others are devotees of Web sites such as www.stocksplits.net and www.splitpredict.com that claim to accurately forecast splits.
Amid all the interest, it's not uncommon for an announcement of a split to drive a stock's price up 5% or more. Ikenberry thinks there's a good chance these high initial increases will reduce the longer-term post-split gains he has documented. So investors who want a quick pop now may have to buy before news of a split hits the street. Indeed, Standard & Poor's (like BUSINESS WEEK, a unit of the McGraw-Hill Companies) found that the 359 stocks split two-for-one or more by NYSE-listed companies between January, 1995, and December, 1997, fared almost twice as well as the Standard & Poor's 500-stock index in the 20 days before the splits. They then lagged over the following year.
NO SURE THING. As much as stocks gain when splits are declared, they do even better in the months leading up to the announcement. "It's not that difficult to guess which stocks are going to split," says Joseph Tigue, managing editor of S&P's newsletter, The Outlook. It has published a list of split candidates for more than two decades (table). About 90% of them took place, Tigue estimates. The Outlook dopes out splits by selecting companies that have split their shares in the past. It then looks for rising earnings and forecasts of more growth, and checks whether the company's stock is trading around the price where it split before. Among current candidates: SmithKline Beecham and Tyco International.
Still, there is no sure thing. When Cisco Systems released strong quarterly earnings on Feb. 2, the stock declined. One possible reason: Investors had been driving the stock up in anticipation of a split, then sold in disappointment when none was announced. More ominous are instances in which companies use splits to boost flagging stock prices. Warning signs include a poor performance in the year before the split announcement and an already low share price of $30 or under. Happily, Ikenberry found that only about 5% of the 1,275 companies he studied fit that description.
Perhaps the biggest question confronting investors who chase stock splits is whether their efforts have a future. The risk is that with so many recognizing the money to be made, gains will be arbitraged away--or worse.
Skeptics argue that since stock splits do nothing to enhance a company's intrinsic value, those who pursue them will eventually fail. "This game has worked pretty well so far, but it is not investing," says William Fleckenstein, president of Fleckenstein Capital, a private investment partnership. Whichever side of the debate you come down on, make sure you don't buy a stock simply because you think it might split. If you like a company's fundamentals, you will be happy to hold its stock--divided or not.