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August 3, 2020

The WSJ on Aug. 1, 2020 seeks to educate us all on the bullish impact of stock splits:

Stock Splits Pay Off—on the Rare Occasions They Occur

Stocks in the S&P 500 tend to rise 5% in the year following share splits, including 2.5% immediately following the announcement, according to research from Nasdaq Inc. on splits between 2012 and 2018.

“Splits make stocks look better” to everyday investors who would otherwise be put off by a stock’s high sticker price, said Phil Mackintosh, Nasdaq’s chief economist. “And the premium they gather seems to be long-lasting for companies. Investors keep coming into the stock even 12 months later.” (…)

[Apple] rose 10% to $425.04 on Friday, extending its gain so far this year to 45% after the iPhone maker also reported stronger-than-expected earnings on robust sales of apps and its work-from-home devices. The company added about $172 billion in market value, a one-session gain that tops the size of Oracle Corp., Chevron Corp. and McDonald’s Corp.

While the split won’t affect Apple’s valuation, which swelled to $1.817 trillion on Friday, it has implications for investors, as well as for two of the stock indexes in which Apple resides: the Dow Jones Industrial Average and the S&P 500 index.

After the split, Apple’s influence on the Dow will shift from being the most consequential to the middle of the pack. That is because the Dow is price- weighted, meaning the higher the share price, the bigger the influence that stock has over the blue-chip index’s daily price swings.

Had Apple split its stock at the end of last year, the Dow would be off about 10% in 2020, compared with the 7.4% decline it currently registers, according to Dow Jones Market Data. Besides resulting in a smaller role in the Dow’s moves, the change would likely widen the performance gap between the 30-stock index and the broader S&P 500, which is up 1.2% this year and weighted by market value. The divergence between the indexes in 2020 is already at the widest mark in decades. (…)

About 41% of the stocks in the S&P 500 currently trade above $100, the level that once spurred executives to consider a split. Just three companies, including Apple, have unveiled plans for share splits this year. That is down from 102 companies in 1997 and seven in 2016, according to Charles Schwab Corp. (…)

Investors previously found better pricing deals on trades if they were willing to buy round lots of 100 shares rather than on odd lots of stock that carried steeper commissions. (…)

Ramon Laguarta, the chief executive of PepsiCo Inc. dismissed in May the possibility of a stock split for the company, whose shares trade at $137.66. He blamed administrative costs associated with such a move as a deterrent, adding that the expense outweighs the benefits in terms of potential value creation for the company. One academic paper pegged the administrative cost of a stock split as high as $800,000 for a large company. (WSJ)

Hmmm…Ramon, Apple’s value swelled by $172 billion last Friday, covering expenses 215,000 times…PEP’s market cap is $190B. Even a 5% pop, per the Nasdaq “research”, equals nearly $10B. What if you or your CEO had options expiring soon?

The empirical study likely to get the most media exposure on stock splits is the 1996 study by David Ikenberry of Rice University who analysed 1,275 companies whose stock split 2-for-1 between 1975 and 1990.

Overall, the evidence suggests that although splits appear to be directly motivated by a desire to maintain a trading range, it also appears that the decision to initiate a stock split is made conditional on favorable expectations regarding future performance. Thus indirectly, splits are informative…Split firms experience an additional permanent excess gain of 7.94% in the first year after the declaration. After three years, compounded excess performance exceeds 12.14%.

In August 2003 Mr. Ikenberry updated the study, adding the period 1990 to 1997. Results were essentially the same. Shares of split stocks on average outperformed the market by 8% the following year and 12% over the next three years.

Truly amazing! Two studies, two periods, exactly similar results.

Imagine what Jeff Bezos left on the market table, had he been splitting AMZN 2 for 1 every time the stock hit $100. Six splits over the last 10 years and 8% excess annual returns each shot: AMZN’s current $1.6T market cap would be $2.5T. That’s a lot of money Bezos failed to deliver! AMZN’s price/cashflow would be 60, not its current 38.

One could think one now has enough info backed by solid empirical analysis to conclude that stock splits are generally good for stock prices and move on to improve one’s golf game, ski in the Alps and live the high life, simply awaiting future split announcements to build one’s portfolio using this very simple factor and easily beat equity markets year after year.

After all, with 85 stock splits per year (1975-90 annual average), it should be easy to build a well diversified portfolio and handily beat the market.

Unfortunately, Jinho Byun (Korea Securities Research Institute) and Michael S. Roseff (University of Buffalo) published in 2003 an analysis of all previous analysis while also performing their own calculations of post-split performances of 12,747 stock splits between 1927 and 1996. Their conclusion with my emphasis:

Between 1927 and 1996, neither method applied to splits 25 percent or larger finds performance significantly different from zero. Over selected subperiods, subsamples of 2–1 splits restricted by book‐to‐market availability requirements display positive abnormal returns using some methods. However, these samples show small or negligible abnormal returns using the calendar‐time method. Overall, the stock split evidence against market efficiency is neither pervasive [“spreading widely”] nor compelling [“inspiring conviction”].

And their explanations (my emphasis):

Since splits are widely reported and noted, a stock split anomaly would be a particularly flagrant violation of market efficiency. We ask whether returns after stock splits actually do allow investors to capture abnormal returns. Our paper suggests that the stock split does not provide evidence against efficient markets when the entire record is examined.

(…) there is a strong contradiction between earlier and later empirical findings. Fama et al. (1969) (FFJR) find no abnormal performance subsequent to stock splits, whereas both Ikenberry, Rankine, and Stice (1996) (IRS) and Desai and Jain (1997) (DJ) report abnormal returns of seven to eight percent in
the 12 months following stock splits. (…)

Since earlier and later stock split studies employ very different methods, we alleviate the incomparability by uniformly applying a broad set of up-to-date abnormal return and statistical testing procedures to all the subperiods. (…)

Yet another difficulty in assessing long-term performance arises from sampling variation. Mitchell and Stafford (1998) find that “comparison of our estimates to those of other researchers reveals that slight modifications to either the sample or the methodology can produce dramatically different results.”

(…) particular methodological choices do have a marked influence on outcomes. The use by IRS of 2-1 splits together with book-to-market matching gives a restricted sample of 1,802 observations. However, we find 6,918 splits of size greater than 25 percent between 1975 and 1990. We can evaluate all of these if we use size matching only, since the latter does not require that book values be available on COMPUSTAT. For the 6,918 splits, the control and split firms differ by merely 0.55 percent, an inconsequential and insignificant difference.

More recently (2012), Alon Kalay (Columbia U.) and Mathias Kronlund (U. of Illinois) published “The Market Reaction to Stock Split Announcements: Earnings Information After All” analysing 2,097 stock splits between 1988 to 2007. Having read all 49 pages, I can save you time saying that this research is mainly concerned with relative earnings and relative earnings revisions, not long-term price performance (my emphasis).

While many theories have sought to explain the presence of abnormal returns around stock splits announcements, our evidence reaffirms the earnings information based explanation discussed in the accounting literature by Asquith et al. [1989].

We find that analysts increase their earnings estimates around stock split announcements, and that the revision is greater for firms with more opaque information environments [measured by fewer analysts and lower
market capitalization]. Furthermore, the earnings forecast revisions for splitting firms is significantly higher than that for matched firms, indicating that the observed increase in earnings estimates does not result from analysts sluggishly revising their forecasts in response to the splitting firms’ past performance. (…)

Finally, we find that the future earnings growth of the splitting firms is higher than that of matched firms with similar past earnings growth, for up to two years following the split. While both the splitting firms and the matched firms experience lower earnings growth in future periods after the split compared to their own past earnings growth, the future earnings growth of the splitting firms is nevertheless higher than that of the matched firms. This result implies that the earnings growth experienced by the splitting firms before the split is less transitory in nature than the pre-split expectations (as proxied by the performance of ex-ante comparable firms). This result helps explain why analysts revise their expectations of future earnings following a split announcement and increase their earnings estimates. This positive change in expectations is likely to be a primary reason why the market views a stock split announcement as favorable news. (…)

In addition to our results which reaffirm the information hypothesis, we find
that in years when the low-price premium is higher, indicating periods where investor preferences for low-priced stocks increased [smaller caps?], split announcement returns are not higher on average (and significantly negative in some specifications).

Yes, it comes down to earnings and earnings visibility.

I bet stock splits will become more popular.