Stock Splits: With So Many Stocks At Or Near Record Levels, Why So Few In Recent Years?

We mentioned in our last issue that we were overdue in covering stock splits – or, more precisely, the notable dearth of splits there’s been over the last few years – even while more and more seemingly split-worthy stocks are at or near record price levels…So here’s our promised update:

On the day we began drafting this, June 18th to be exact, 41 of the S&P 500 stocks closed at $70 or above - and that’s excluding the famously never-to-be-split Berkshire Hathaway shares. Another 13 of the 500 closed higher than $60 that day.

So what’s the magic here? In our long market-watching and split-watching experience, $35 is the “magic number” – the minimum stock price one would want to see after a two-for-one split – and hello…most stocks selling in the low 60s typically achieve that projected post-split number as soon as such a split is announced.

So why have we been seeing so few stock splits? The answer is a simple one, we think – a near total lack of attention to retail stock ownership on the part of “big companies” – and many smaller ones too.

Many such companies take refuge in the “simple math” – that in mathematical terms, nothing really changes with a split; one simply ends up with twice the number of shares at half the price, for the same dollar value as before. Others, like Warren Buffett in particular, point out that “serious investors” get it, and thus, don’t give a hoot about splits…and that a “high stock price” is decidedly not a “bad thing” at all – and maybe will even attract more of the most serious buyers. And, partly due to Buffett and partly to the Amazons, Apples and Googles of today, there is a certain cachet in having a really high stock price these days.

Also, as Buffett is always quick to point out, stock splits actually cost shareholders money, because most brokers - and DRP agents too – tend to tack on a per-share charge to their basic commission rates for buying and selling. So investors get nicked on both ends. And yes, stock splits cost the issuer “more money” too – though, unlike the old days, when new stock certificates needed to be purchased, and issued, hand-signed and hand- legended - then enclosed, insured and mailed with a little explanatory note – most splits are effected via “book-entry” these days, so cost is not the big factor it used to be – when splits, oddly enough, were a lot more common.

But let’s go back now to that Magic number” – and ask what exactly makes it so “magical” that stock splits, in our book, make such a great amount of sense – and such a great deal, most times, for investors:

First, most market watchers will say that $35 is as close to a retail investor’s “ideal price point” for buying in – or for buying more – as one can get: If you want to attract more retail investors – or if you simply don’t want to see retail investors buy Coke over Pepsi, or Colgate over P&G let’s say - this is the number to focus on.

Second, and far more important to note, there are a host of factors other than the “pure math” that affect one’s buying decisions – whether one is an ordinary retail investor or a professional – that do indeed affect the longer-term stock price. Just look at the 5-10% ‘kicker” that the mere announcement of a stock split tends to kick off, for starters: A stock split sends a very bullish signal that management – and the directors – expect the stock to go higher, going forward, as the vast majority of post-split stocks DO.

Most managers also know that a stock that sells at - or drops - below $30 sends a BAD signal to the marketplace.

So they are likely to be doubly cautious – and mighty certain about maintaining and ideally increasing the dividends too - before authorizing a split…and investors know it.

Now back to that “magic” $35 number and what makes it so magical: It’s mostly, but not entirely due to “investor psychology” rather than to the pure rationality of the pure math: Yes, average investors DO understand the bullish signals a stock split sends. And yes, average investors are wary – and rightly so, we think, of stocks that are, or that fall below $30…as signaling “weakness.” But, investors simply feel richer owning 100 shares of a $35 stock than when they own 50 shares of a $70 stock. Given a choice between two stocks in similar industries – with similar outlooks and similar yields – investors will always favor buying the lower-priced one. So the added demand actually does give it a mathematical “edge” over higher-priced peers. And, let’s face it – it DOES seem to be a much easier hurdle, and a lot more likely – and a lot quicker to achieve too - for a $35 stock to go up 10% to $38.50, or 20% to $42 – than it is for a $70 stock to go to $77, much less than to $84.

There is some very strong empirical evidence to back our theory about stock splits producing superior returns to investors: A mid-June WSJ column by Mark Hulbert cited an investment advisory service called “2- for-1” that buys only stocks that have spit their shares – then holds them for 30 months. That portfolio, according to the Hulbert Financial Digest, has produced a 14% annualized return over the past ten years, vs. an 8% gain for the S&P 500 stock index, with dividends reinvested.

Even as we write this we seem to be seeing a sharp and much overdue correction in the number of stock splits: So far this year 25 companies have announced splits of 2-for-1 or larger splits - vs. only 12 in all of 2009 and only 13 last year – including Coca-Cola and Colgate Palmolive, that split after our initial heads-up - culminating most recently with high-priced Google, whose stock rose a nifty $14+ on the date of the announcement.