- Stock splits theoretically aren't supposed to make any difference to performance, however, most empirical data suggests that they do.
- One famous study published in 1996 by Dr. David Ikenburry of Rice University found that stocks which split 2-1 between 1975 and 1990 on average outperformed the control group he created by 8% after one year and by up to 12% after three years.
- By the looks of Apple's performance, it seems that splitting stocks are still doing just fine.
Yesterday Apple's (NASDAQ:AAPL) stock underwent an unusual 7 for 1 split, bringing the price of an individual share down below the $100 mark. Stock splits theoretically aren't supposed to make any difference to performance, however, most empirical data suggests that they do.
In a traditional 2 for 1 split, all owners of common stock have their share counts doubled while the price is simply cut in half. Shares are now worth half as much as they were before, but there are twice as many available and the percent ownership of each shareholder is unchanged.
There have been many studies done on the price effect of stock splits over the years and many theories have been generated on why such correlations exist. Most of the data surrounding stock splits seems quite bullish. One famous study published in 1996 by Dr. David Ikenburry of Rice University found that stocks which split 2-1 between 1975 and 1990 on average outperformed the control group he created by 8% after one year and by up to 12% after three years. Another important conclusion the researchers reached which is illustrated above is that pre split and post split stock performances were inversely related, derailing the argument that momentum alone drove the shares' strength.
In 2003 Dr. Ikenberry updated his original research including data from 3-1 and for 4-1 splits and found that the results from 1990 to 1997 were practically identical to the findings from the original study. A further joint study published in 2003 from the Chinese and City Universities of Hong Kong and the Hong Kong Polytechnic University corroborates Ikenberry's findings with similar evidence from the stock market in Hong Kong.
One of the popular theories to explain why stocks perform better after splitting is because they become more affordable to smaller individual investors. For example, a middle class individual may not be willing to sink $600 into a single share of Apple, but they may be amenable to spend $300-$400 on 4 shares after the 7-1 split.
Recent figures have suggested that the behavioral reasons that stocks perform well after splitting may be deteriorating. Bloomberg Businessweek found that in 2011 and 2012 stocks that split showed a median gain of 6% compared to a benchmark rise of 4.5%. Furthermore, researchers from The Wharton School of Business found that institutions have increased their percent ownership in stocks from 34% in 1980 to 67% in 2010, and it's widely believed that institutions like mutual funds are less susceptible to psychological biases like a lower sticker price than non-professionals.
Evidence does give credibility to the theory that stocks perform well after splitting in part because they become more accessible to mom and pop investors. At the same time, calling marginally better than expected performances of splitting stocks over a 2 year period evidence that all is explained is making a leap of faith as well. Another leading theory, proposed by Ikenberry along with the original paper in 1996, is that stocks perform well when they split because the split itself is a signal of bullish sentiment from management.
Apple's earnings and revenue performances have been moving along nicely, but the company hasn't had a new product catalyst to ignite its fundamentals since the iPad was released in 2010. This year, CEO Tim Cook has promised several new types of products and that may be the reason Apple's management has the confidence to split the stock. It's entirely believable that splitting stocks do have a positive selection bias. What could be worse for a CEO than taking a high value stock, splitting it into pieces, then seeing the face value fall even further sending investors into a panic? There would be a mutiny.
The fact is that Apple's stock has performed very well going into its split. According to the inverse relationship between pre and post split price action published by Ikenberry, on average one would expect Apple's rampage to slow down this week. Apple did post a stronger than expected quarter in April, beating the Estimize consensus on both and top and bottom line, but much of the share buying this year has likely been predicated on speculation about the success of the mysterious new products that Apple has in store for us. It may be a while until we get another 1,275 data point tome on stock split price action like the one Ikenberry first gave us, but by the looks of Apple's performance, it seems that splitting stocks are still doing just fine.
Disclosure: No positions