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What's in a stock split?
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April 29, 1999: 12:05 p.m. ET
Splits may have no inherent value, but they could yield other clues
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NEW YORK (CNNfn) - When online superstar Amazon.com put into place a 3-for-2 stock split this past January, its stock jumped more than 13 percent in one trading session.
Within days, the company's shares (AMZN) had ballooned a stunning 68 percent.
Microsoft Corp. (MSFT), too, benefited from a 2-for-1 stock split announcement in January that sent its stock up a slightly less striking 4 percent in one day and as much as 8 percent by the week's end.
And then there was theglobe.com (TGLO), whose shares skyrocketed 26 percent earlier this month after the hot startup Internet company unveiled a 2-for-1 split.
This type of investor euphoria is not uncommon when it comes to stock splits these days, even though most analysts agree splits have no effect on a company's value.
So what's going on?
Dissecting a stock split
Usually, companies authorize stock splits in the hope that cheaper shares will lead to increased investor interest. A company may also authorize a split in a move to increase liquidity, reduce volatility and broaden its shareholder base, thereby diminishing the chances of a hostile takeover.
A stock split increases the amount of shares that exist, but does not change the value of an investor's holdings or the market value of the company. For instance, one share worth $100 becomes two shares worth $50 each in a 2-for-1 stock split. Splits can occur in any combination: 2-for-1, 3-for-2, 5-for-3, etc.
Because stock splits have no impact on the fundamentals of a company, the interest garnered by stock splits is generally considered strictly psychological.
"A stock split technically doesn't mean a thing," Arnie Kaufman, editor of Standard and Poor's The Outlook, said. But "for whatever reason, people prefer to buy a stock at $30, rather than $60."
Years ago, that reason was more substantive. Brokers were once fined for purchasing "odd lots" -- less than 100 shares -- of a certain stock and splits enabled smaller investors to buy "round lots" they previously may have been unable to afford.
But those penalties have long been eliminated, making recent post-split rallies more difficult to explain.
Investors to blame?
Some analysts blame the introduction of a new crop of investors into Wall Street.
"Many of the newer investors may not understand what stock splits are about, but they think they're good anyway," Kaufman said. These investors "are just attracted to the glamour of the market and the publicity it is getting and they are not taking the time to understand what stocks are all about."
In addition, the growing role of day traders on Wall Street may explain the post-split bounce experienced by some companies, as these drastically short-term investors try to cash in on any stock-related news.
It's the fundamentals, stupid!
Meanwhile, some research does seem to indicate a positive correlation between stock splits and stock prices.
A study of the performance of 2,750 companies from 1975 to 1990 conducted by Rice University professor David Ikenberry found that shares climbed, on average, about 3.4 percent in the days immediately following a stock split.
More significantly, the study found that over a three year period, shares that were split outperformed comparable issues by about 8 percentage points the following year, almost 9 percentage points the second year, and 12 percentage points the third year. (see chart)
These figures indicate some long-term investment significance can be gleaned from stock splits.
"Stock splits in and of themselves have no redeeming economic value, but they do contain information," said Ikenberry. "That is, companies don't just randomly split their shares. They tend to do it when they are optimistic about where the company is headed."
In addition, the strong performance of the stocks that split could be related to the fact that companies which split tend to be among the fastest growing firms to begin with.
No sure bets
But analysts insist splits are no way to pick stocks.
"You need to analyze stocks on the valuation and prospects of the company because that's what counts in the end of the day," said Tom Hensel, a technology analyst for Everen Securities. "I couldn't recommend a stock simply because of a split."
In addition, not every stock that splits is a guaranteed winner.
A study of 359 New York Stock Exchange issues by Standard and Poor's found that though share prices of companies that split their stock grew an average of 16.2 percent during the following year, the S&P 500 outdid that, gaining 28.2 percent. In fact, only 30.6 percent of the split stocks evaluated outperformed the index.
Making the most of splits
So what's an investor to do?
The key, says Kaufman, is to see a stock split as tip-off and then seek out additional clues.
For one, make sure the company that's splitting has "honorable" intentions.
Companies that have major stock incentive plans, for example, may use stock splits to bolster their management's compensation packages. Others may be trying to raise funds to pay off debt.
In addition, if a stock price has been fairly flat in the month preceding the split or is just generally low -- below $45 -- proceed with caution. Stagnant or low earnings and growth rates are other warning signs.
Finally, don't see a stock split as way of making a quick buck.
The rise in a company's shares the day after a split may seem like an invitation to sell, but chances are, if the company is a strong growth and earnings performer, bigger gains could be waiting down the road. 
-- by staff writer Nicole Jacoby
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