- Studies show that stock splits can provide abnormal returns through increased investor access and/or price momentum.
- Stock splits examined from 1927 to 1959 had no abnormal returns; however, it appears stock splits after 1959 provide abnormal returns. Perhaps the trend is widening with time.
- FELE, JAH, and TRMB had splits a year ago and they have 1-year returns of 28%, 44%, and 29%, respectively.
- I'll research whether or not Westlake Chemical Corp fits the profile for a "stock-split" portfolio -- its shares split 2:1 this morning before the bell.
In 2005 a study was published by Oliver Rui, Steven Wang and Tak Yan Leung that makes the following claim:
Although stock splits seem to be purely cosmetic, there is ample empirical evidence that they are associated with abnormal returns.
Stock splits are not only great for the additional media attention, but they allow more investors to purchase the stock at a lower price. According to an article published by Barron's, low-priced stocks outperformed high-priced ones by 4.6% in 2013.
Stock splits were first examined from an investment perspective in a seminal paper published by Fama, Fisher, Jensen, and Roll in 1969 examining stock splits from 1927 to 1959. They found no abnormal returns in the 30 months following the split. Another study conducted by Ikenberry, Rankine, and Stice in 1996 found abnormal returns of 8% 52 weeks after the announcement, and 16% three years later. The study was repeated in 2003 and created similar results.
The primary difference between each study is the period of time. It appears that stock splits after 1959 may provide abnormal returns. Indeed, a study by K.C Chen, Sangphill Kim, and Peter H. Xu found that abnormal returns are largest in the period from 1976 to 2002.
The focus of this analysis will be for stock splits on or after the excise date, or the date the split goes into effect. This is because it's too difficult to time the market and it's unnecessary.
Neil Macneale is the editor of an investment-advisory service called "2 for 1". His portfolio only contains stocks that have undergone 2 for 1 stock splits.
In an interview Macneale is asked about predicting stock splits:
Q: Do you ever try to predict stock splits? Are there signs?
A: I don't try to predict splits. I don't need to. It's not part of the methodology. But there are a few signs. Most companies seem to have, whether explicit or not, an ideal trading range. For the big industrial stocks, most people think 100 is as high as they want to go and they don't want to go below 30 to 40. Midpriced stocks often see that limit as $50. Part of the theory here is that a board will probably not split a stock if it devalues the image or perception of the stock.
Many investors that watched shares rise at the announcement and again during the run up to the split, will continue to buy shares at the lower price, which can push prices up even higher. Your total return may not be as high, but you won't be waiting on a "winner" either.
Macneale is also asked about what aspects he looks for in a pick:
Q: You add only one stock per month to your portfolio. When you're looking at a split stock, what fundamental characteristics put it at the top of your buy list?
A: I look at the P/E, book value and price-to-book. I look for good earnings, good growth. I like dividends because they're an indication that companies know who they're working for. I consider myself a value investor.
Macneale holds the stock for 30 months, which is line with Ikenberry's research studies. Indeed, Macneale admits that he got the idea for his portfolio from a study that Ikenberry published.
Still others argue that the price return on stock splits is little more than price momentum. You can find a decent contrarian view here by David Merkel a Seeking Alpha contributor -- we both reference some of the same literature.
As a quick little experiment I decided to look at the one year price returns for those stocks that split on March 18-20 last year. They are Franklin Electric (NASDAQ:FELE), Jarden (NYSE:JAH), and Trimble Navigation (NASDAQ:TRMB). Franklin has a 1-year price return of 28%. Jarden has a 1-year price return of 44%, and Trimble Navigation has a 1-year price return of 29%.
The good news is that all the shares went up in value. The bad news is that this is hardly a scientific study.
Let's take it a step further. I'll test this theory with a virtual portfolio that I'll monitor for the next 30 months. Westlake Chemical Corporation (NYSE:WLK) will be the first company in the portfolio. The company had a 2 for 1 stock split that took place today, March 19.
Westlake Chemical Corp
Founded in 1985, and headquartered in Houston Texas, Westlake Chemical Corporation manufactures and markets basic chemicals, vinyls, polymers, and fabricated building products. Yesterday the stock closed at $135.16 and today it opened at $67.62.
Before the split the mean price target, according to a group of 10 brokers, was $127.50, the high target was $150 and the low target was $55. Based on these opinions the stock appears overpriced.
The P/E for the industry is 14.7; WLK has a trailing P/E of 14.7, and a forward P/E of 12.6. Price, at least from a relative value perspective, is in line with the industry.
From a revenue and earnings perspective, the company made $3.76B in revenue over the last 12 months with 19% quarterly revenue growth. Earnings per share is $4.55 (yoy quarterly earnings growth of 80%). Cash per share is $5.26 and book value per share is $18.14.
From a technical perspective the MACD and relative strength indicate a bullish trend. Additionally, both the 50 and 200 day moving averages are rising.
On the whole, Westlake Chemical appears to be a strong company with healthy revenue growth. It fits the profile of the stocks in Macneale's portfolio and Ikenberry's studies, however, P/E is at the market which may be a concern in the future.
If you doubt the theory that a successful portfolio can be built using stock splits, there's always the "price momentum" theory, or the "great PR" theory. That said, the studies prove there's something about stock splits that drive up the price of a stock even after the excise date. What's more, much like insider trading, they give the investor a signal for assessing management's true sentiment for the company.
Please let me know if you have any suggestions. I'll be sure to provide updates as this series progresses.