Do Split Stocks Do Better -- Or Worse?
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Apple's 7-for-1 stock split—which dropped the company's share price to less than $100 a pop—has individual investors wondering if now's the right time to buy the stock .
While no one signal is enough to tell you whether to buy, several studies suggest that stocks tend to perform well after a stock split.
A famous study from 1996 by David Ikenberry, currently dean of the business school at the University of Colorado, Boulder, found that stocks produce nearly 8% excess returns in the year after a split and more than 12% in the three years after.
A more recent study suggests that companies that split their stocks experience more sustainable positive earnings growth than companies that don't—at least for the following two years after the split. (This may not be causal relationship, but rather a correlation that teases out businesses that happen to be in a fast-growth phase).
The draw of higher returns is what prompted newsletter editor Neil Macneale to create the "2 for 1 index," a model portfolio that holds companies that have announced a stock split in the last six months. His portfolio has about doubled the S&P 500's returns over the last decade.
While there isn't perfect consensus on why there's a positive relationship between splits and returns—after all, a split is a mere technical adjustment that changes nothing fundamental about a company—leading theories suggest a combination of factors. One is that splits signal that management believes their company is healthy—another is that individual investors are simply more comfortable psychologically with lower sticker prices. That is why stock splits were so popular—and profitable—three decades ago, says Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. But market forces can be unpredictable, he says.
"Traditionally individual shareholders are desirable to companies because they aren't as quick to jump out of a stock as mutual funds can be," says Silverblatt. "The question is whether that's still true today. You can't assume because something worked in the '80s that it will work today."
One key way the market looks different from how it did in the 1980s, says Silverblatt, is that far fewer companies are splitting their stocks. One reason? Rising household income means individuals are more willing to pay higher sticker prices for shares—and public companies rely increasingly on institutional investors, like mutual funds, which aren't put off as much by share prices in the $100s (or $1,000s).
A note of caution: Before you march out and buy Apple, or any other freshly-split stock, remember that research is not unequivocal about stock splits being a good thing, particular in long-term investments. One study even found that over longer-term periods, some splits are correlated with lower profits.