While this might not be universally true of every stock that splits or for stocks that split during a boom, it seems to be true for the vast majority of stocks. To verify this theory, I started looking for any long-term studies that were done to compare the returns of stocks that split vs the general market. I found an interesting LA Times article that mentioned an academic paper called "What Do Stock Splits Really Signal?" by professors David Ikenberry, Graeme Rankine and Earl K. Stice. This paper looked at the returns of 1,275 companies that declared stock splits between 1975 and 1990 and found that in the first year after the effective date of the split, these stocks outperformed a benchmark group of companies by 8%. Over a period of three years, the results were even more impressive with these stocks outperforming the benchmark group by 16%.
I then contacted the authors of this paper to see if they had continued this research and if they did, was there a significant change in the results. Professor David Ikenberry who is currently the Chair of the Department of Finance at the University of Illinois, Urbana-Champaign was kind enough to write back to me and sent me another paper called "Underreaction to Self-Selected News Events: The Case of Stock Splits" that he had published along with Sundaresh Ramnath. The results of this second study which looked at stocks that declared splits between 1988 and 1997 were similar to the first study. The mean return of stocks in this group was 9% higher in the first year after the split and the median return was 6.37% higher when compared to a control group.
The reason for these higher returns? After ruling out factors such as increased coverage by analysts, Ikenberry and Ramnath concluded that 85% of companies that declare stock splits tend to have higher earnings growth in the ensuing years and analysts that follow these companies are slow to revise their earnings expectations upwards. This underreaction contradicts conventional wisdom and the efficient market hypothesis. However based on data from over 30 years, this underreaction to stock splits is an anomaly that could be exploited to boost returns. The two stocks featured in this month's SINLetter are based on this research as they have both proposed stock splits in recent weeks.
Switzerland based Logitech International (LOGI) recently proposed a stock split and a $250 million share buyback program. In addition to the study of stock splits discussed above, numerous academic studies have also shown that companies that announce share buyback programs and then actually execute them (strangely enough some companies do not follow through on a buyback announcement) outperform the general market. Logitech is a company that makes a wide range of computer accessories and is well known for its web cams, computer speakers, cordless mice and keyboards. The company also has strong product lines for computer headsets, bluetooth headsets for cell phones, iPod speakers, game console accessories such as racing wheels and remote controls.
I recently started using Skype to communicate with my off-site project team and visited the neighbourhood Circuit City (CC) looking for a headset. The Logitech headset I was looking for was out of stock and so I picked up a Cyber Acoustics headset instead. Much to my disappointment, I realized that I must have a larger head than the designers at Cyber Acoustics imagined. I returned the Cyber Acoustics headset and picked up a Logitech one instead at a different Circuit City. With over 74.7 million registered Skype users at the end of 2005, the popularity of massively multiplayer online role-playing games [MMORPG] like World of Warcraft, the proliferation of iPods and the use of web cams for communication and security, it should come as no surprise that Logitech is doing well. This is probably what lead to the following comment made by the Chief Financial Officer of Logitech during the quarterly earnings conference call "PC headsets really are riding I’d say the wave of the voice-over-IP communications and contributed to sales growth of 61% and unit growth of 69%.".
Skype's recent move to offer phone calls for free when calling any phone in the US or Canada from a computer should further ignite the sales of headsets for Logitech. Another driver of growth would be the next generation of gaming consoles such as the Microsoft XBOX 360, the Nintendo Wii and the Sony Playstation 3 that can connect wirelessly to the internet to enable online gaming. Logitech's high end Harmony line of universal remote controls that have a color LCD display, a recharging station and a USB interface to download updates from a computer (I never imagined a day would come when my remote control would require software updates) is gaining traction in Europe.
With the business obviously doing well, lets look at some of the numbers. With a forward P/E of 17.73, a P/S of 2.07, a strong balance sheet that sports $245 million in cash when compared to just $14 million in debt, a quarterly revenue growth rate of 15.7% and a quarterly earnings growth rate of 27.1%, Logitech appears to be attractively valued. According to the latest quarterly results, inventory dropped from $258 million in the fourth quarter of 2005 to $197 million in the fourth quarter of 2006, which is very positive. Cash flow from operations was up 15% year-over-year reaching a record-breaking $137 million in the fourth quarter of 2006. Their tax rate for the latest quarter was a little over 13% and will be around 14% going forward. Comparing that with a tax rate of almost 40% for SINLetter pick Medifast (MED) makes one realize why Logitech is generating a healthy amount of free cash flow each quarter. Logitech certainly appears to have excellent long-term potential and I personally plan to start a position in Logitech after this newsletter is sent out to subscribers.
Logitech faces competition from Plantronics (PLT), Creative Technology (CREAF) and Motorola (MOT) in the headset segment, Singapore based Creative Technology in the web cam and speakers segments, and Microsoft (MSFT) in the wireless mice and keyboard segments.
* Logitech recently announced a stock split and a $250 million share buyback program.
* Attractive valuation with a forward P/E of 17.73 and a Price/Sales of 2.07.
* Logitech is likely to benefit from increased Voice-Over-IP [VOIP] activity from Skype users.
* The next generation of gaming consoles such as the XBOX 360, Wii and Playstation 3 will contribute to future growth.
* A very strong balance sheet and excellent free cash flow.
* Sales in retail gaming fell thanks to a drop in sales of console accessories and in spite of an uptick in sales of PC gaming accessories. The release of the Playstation 3 and the Nintendo Wii should hopefully reverse this trend.
* The tax rate will increase marginally from a little over 13% in the latest quarter to about 14% going forward.
* Competition in the headset segment is stiff as evidenced by the disappointing quarterly results released by Plantronics.
P/S 2.03 Cash $245 Million P/E 22.16 Long Term Debt $14 Million