Today I read this interesting S.A. article about V.F. Corporation (VFC), an American apparel and footwear company. The company reported better than expected third quarter results, raised its dividend by 21% and announced an 4:1 stock split. Especially the announcement of the stock split stood out for me. I decided to take a closer look at V.F. Corporation by evaluating historical stock splits. This article provides an insight whether the announced stock split is an indication for outperformance of V.F. Corporation shares in the weeks after the upcoming stock split.
V.F. Corporation, founded in 1899, designs and manufactures apparel and footwear under some familiar brands like: The North Face, Timberland, Vans, Kipling, Wrangler, Lee and Majestic. The company's headquarter is located in Greensboro, North Carolina. Main competitors are Nike (NKE), Ralph Lauren (RL) and PVH Corporation (PVH). V.F. Corporation shares are performing quite well this year, resulting in a total return of 45.5 percent year to date. Full year 2013 revenues are expected to be approximately $11.5 billion and earnings per share around $10.78 on a US-GAAP basis. This represents an 11 percent year on year increase in US-GAAP earnings per share.
On October 21, 2013 V.F. Corporation announced the 4:1 ratio stock split together with its third quarter earnings. The split of the company's common stock shares is payable in the form of a stock dividend on record date December 10, 2013. For each common stock share, shareholders will receive three additional shares of common stock, payable on December 20, 2013. Such stock splits in the form of a stock dividend are not uncommon.
Stock split arguments
A stock split results in an increase in the number of outstanding shares by dividing a common share according to the split ratio. The split will lower the share price, without changing the company's actual market capitalization. If market capitalization will not change as a result of the stock split, why do companies split their outstanding common shares? I will discuss two reasons: 'the philosophy argument' and 'the trading float argument'.
The philosophy argument plays investors' subconscious. Theoretically is a high share price interpreted as an expensive stock by investors. Also, small private investors will hesitate to buy a stock with a high share price. It is all about investors subconscious behavior. Following this theory, demand for the shares will decline when share price goes up, leading to lower stock returns in the long-term.
The trading float argument is a more technical argument. Higher share price are assumed to lead to higher bid/ask spreads. As a result of higher bid/ask spreads, float of the shares will decline. This is also known as liquidity. To decrease bid/ask spreads and improve liquidity, companies can split their stock, leading to lower share price, lower bid/ask spreads and improved liquidity.
Historical post-stock split returns
Two theoretical stock split arguments are mentioned above. Usually a stock split announcement is made after a long-term period of increasing share price. The gains of a share price could have a lot of reasons. I assume a long-term increase in share price to come from higher than expected company (future) earnings and/or stronger growth opportunities. When a company posts good results and has a track record of increasing share price over a long-term period, it is likely the shares of the stock splitting company will also deliver higher post-stock split returns compared to a benchmark. This theory could also apply to V.F. Corporation.
To test my theory I performed some research regarding recent post-stock split returns. This research concerns the stock split returns of the following ten companies: Cabot Oil & Gas Corp. (COG), Capital Southwest Corp. (CSWC), Westpac Banking Corp. (WBK), American States Water Company (AWR), DaVita HealthCare Partners Inc (DVA), Alliance Fiber Optic Products Inc. (OTCPK:AFAP), Cognex Corp. (CGNX), Tractor Supply Company (TSCO), West Pharmaceutical Services (WST) and Kyocera Corp. (KYO).
My research calculates abnormal post-stock split returns over a one month period after the stock split date. I define abnormal return as the difference between post-stock split return of the stock splitting company (adjusted for beta) and S&P 500 return over the same period. The following principles apply to my research:
- Number of observations N=10
- Stock splits in the period August 8, 2013 - October 9, 2013
- Date prior to stock split (T=0) and T=0 plus one month (T=1)
- Post-stock split return adjusted for beta
- Benchmark: S&P 500
- Outperforming when abnormal return >1%
The results of my calculations are shown below. The one month return of the stock splitting company is displayed in the column "Return Company" (hereafter: Company). The one month return of the S&P 500 is displayed in the column "Return S&P 500" (hereafter: S&P 500). I noted a share as outperforming the S&P 500 when the Return Company was at least 1 percent above Return S&P 500.
The results from my calculations show Company average one month post-stock split return of 5.31 percent, compared to S&P 500 average one month post-stock split return of 2.50 percent. Six observations are outperforming shares (abnormal return > 1 percent), two are equally performing shares (abnormal return between -1 and 1 percent) and two are underperforming shares (negative abnormal return < -1 percent). So, the abnormal return of the stock splitting companies is twice the return of the S&P 500. This outcome underscores my theory regarding shares of the stock splitting companies to deliver outperforming returns after they split their stock.
Please note that my research concerns a very small population and no further statistical test were performed regarding the statistical characteristics of the database used for my research. This means the results are not to be addressed as statistical significant evidence. However, the results support my theoretical analyses considering post-stock split returns.
Other factors to watch
As I mentioned, my research supports my theory. It is likely that stock splitting companies will deliver better returns compared to the benchmark (S&P 500). As an investor I would take into account the information from my research when making a invest decision. However, there are more factors to watch concerning a long-term investment decision. I will discuss V.F. Corporation's current dividend yield and forward price/earnings ratio compared to competitors Nike, Ralph Lauren and PVH Corp.
V.F. Corporation's currently pays a quarterly dividend of $1.05 a share, providing investors 1.90 percent dividend yield (34 percent pay-out considering 2014 EPS estimates). Competitors' dividend yield is lower compared to V.F. Corporation's yield, this favors V.F. Corporation. Nike's dividend yield is 1.10 percent (24 percent pay-out), Ralph Lauren's dividend yield is 0.90 percent (16 percent pay-out) and PVH Corp.'s dividend yield is 0.10 percent (2 percent pay-out).
Second factor to watch is forward P/E per share. I disclosed estimates of V.F. Corporation's EPS according to Yahoo! Finance. V.F. Corporation's forward P/E ratio is 17.7 times EPS, an average ratio compared to competitors. Nike's forward P/E ratio is somewhat higher at 21.8 times EPS, Ralph Lauren's forward P/E ratio is comparable to V.F. Corporation at 17.5 times EPS and PVH Corp.'s forward P/E ratio is somewhat lower compared to V.F. Corporation at 15.3 times EPS.
This article provides an insight whether the announced stock split is an indication for solid returns of V.F. Corporation shares in the future. In my opinion does a stock split imply positive abnormal returns in the future. I found some evidence from ten recent stock splits (as a result of the small population no statistical significance), outperforming the S&P 500 by 2.81 percent (5.31 percent versus 2.50 percent). Given these primarily results I intend to further expend my research to challenge the results. Further I will be looking for statistical significant results in a larger population and over a longer period of time.
For now, I recommend V.F. Corporation shares (initial 'Buy'), because:
- Supporting evidence for outperforming after stock split
- Healthy and stable dividend yield compared to competitors
- Average forward P/E ratio based on analysts estimates
The results described in this article may also apply to several other upcoming stock splitting companies like: Papa John's (PZZA), Sinopec Shanghai Petrochemical Company Ltd. (SHI) and Canadian National Railway (CNI).