Split, and Take the Money

For 25 years, many finance professors at the nation’s top universities have insisted, in stacks of research papers, that companies announcing stock splits are not giving investors any particular signal to buy, scram or stay.

Splits, which lower a stock’s price while increasing the number of shares outstanding, are a non-event in terms of affecting near-term stock price appreciation, say the academics.

So why, then, has the phone at General Electric’s investor relations department rung off the hook since the company’s stock hit $100, with shareholders who are eager to make an extra buck demanding to know if a split is in the works?

The answer is that real investors think the profs are wrong. And new research gives the investors ammunition.

Three recent reports--one from an Arizona university and two from leading stock data analysts--conclude that splits, more often than not, are blazing neon signs erected by the boards of the nation’s best fast-growing companies to declare that even better times are expected ahead.

Best of all, the researchers say, the signs can be followed easily by disciplined private investors to returns 8 to 15 percentage points better than the blue-chip Standard & Poor’s 500 stock index.

The evidence is worth studying, as the surging bull market sends more stocks into price territory where splits typically occur.

Once a stock price shoots higher than the century mark, say experts, many individuals tend to back off from buying because they can’t afford to buy in round lots of at least 100 shares. A company may then split its stock by a factor of 2-1, 3-1 or 3-2 to take the price down for the benefit of round-lot buyers.

Take a look at Dell Computer and Microsoft.

Both announced splits in the last few weeks as their stock prices doubled off 12-month lows to $90 and $145, respectively. And both companies’ stocks rallied even higher on the news of the splits, with Dell at $101 and Microsoft at $152 as of Monday.

Yet according to a paper published in the authoritative Journal of Financial and Quantitative Analysis by Graeme Rankine and two colleagues, history will probably prove that Wall Street is still undervaluing both companies’ messages.

Rankine, a professor at the American Graduate School of International Management in Glendale, Ariz., focused on a sample of 1,275 large and mid-sized companies on the New York and American stock exchanges that split their stocks 2-for-1 from 1975 to 1990.

He found that returns in the first year after the splits’ effective dates were 8 percentage points better than the returns of a group of companies that served as his benchmark. After three years, the split stocks’ returns were 16 percentage points better than the benchmark, he said.

“Our research showed that even if there appears to be a reaction following a split announcement, it’s actually an under-reaction,” Rankine said. “There are, on average, more gains to be had after the stock actually splits.”

Dell, Microsoft and General Electric are classics for split watchers, he said. Their boards have repeatedly split the stocks over the years as the share prices have risen with fast-growing earnings. In other words, he says, a split is like the peal of a gong that signals a new crest for a hard-charging company.

GE has four times split its stock when it reached $100, most recently in 1994. Microsoft has split six times, most recently last year.

Further research, Rankine said, has shown that if a soundly managed company believes its stock is overvalued and likely to fall, it won’t declare a split. “It’s too costly for firms without favorable information to signal falsely,” he said.

To weed out the pretenders, Rankine said, ignore companies that split when their stock price is under $10 or when the price has been either static or falling (showing “relative strength,” as listed in Investors Business Daily, below 50). “Companies that do badly up until the split will continue to do badly,” he said.

Daniel A. Seiver, professor of economics at Miami University in Oxford, Ohio, and author of “Outsmarting Wall Street,” also cautions investors to beware of stocks with high price-to-earnings ratios that split simply because of an irrational run-up. He notes that Netscape Communications split 2-for-1 at $150 when its P/E topped 300, then sank in an otherwise rising market.

Supporting Rankine are researchers at Ford Investors Services in San Diego and O’Shaughnessy Capital Management in Stamford, Conn.

Top money managers around the country pay Ford up to $8,000 a year for access to its database and screening software, and many were intrigued by a study it published June 28 in a quarterly letter to subscribers. (To reach Ford, call [619] 793-2250.)

In a four-page report titled “Stock Splits: Short Cut to Good Fundamentals and Momentum,” analyst Timothy R. Alward says the firm discovered a relatively simple way to produce above-average returns: On the last day of the month, buy all stocks that split 2-for-1 or 3-for-2 in that month, and hold them for three months.

The strategy returned, on average, annualized gains of 32.3% from 1975 to 1995, Alward said, compared with annualized gains of 17.6% for Ford’s benchmark group of 3,300 large and mid-size companies’ stocks. Hanging onto the split stocks for shorter or longer periods reduced the gains somewhat: Holding for one month yielded a 26.4% annualized gain; holding six months yielded a 29.4% annualized gain; holding for a full year dropped the gain to 22.9%.

If you had purchased on June 28 the 32 companies that split 2-for-1 in June and held them until Oct. 31, Alward said, you would have reaped a 10.9% gain, double the S&P; 500’s 5.2% gain. On an annualized basis, the split group’s gain was a 36.2% return.

Even without buying every stock that splits in a month, private investors can use splits as one of their criteria for choosing stocks, said David Morse, Ford Investor Services president.

“If you have 10 to 12 companies that you’re interested in and a couple have split in the last month or two, push those to the top of your list,” he said. “It signals insider thinking. Take advantage of their suggestion that the outlook is bright for the company.”

To double-check Ford’s research, I asked James P. O’Shaughnessy to analyze the 1975-1995 period on Standard & Poor’s Compustat database, considered one of the nation’s finest files of historical market data. A few days later he called back and excitedly declared the results “very, very interesting.”

In rolling one-year periods starting in each month from January 1975 to October 1995, O’Shaughnessy found that total returns (including dividend reinvestment) of companies that had split their stock in the previous month beat the S&P; 500 by 12 percentage points.

Here’s an example: In October 1995, 76 companies split their stocks. If you bought each in equal dollar amounts and held them until the end of last month, he said, you would have reaped a 29.3% gain. The best stock, Zoltek Cos., gained 281%; the worst, Sunglass Hut International, fell 67%.

Seiver pooh-poohs the research of these commercial-data guys in favor of what he called the “preponderance of evidence from the pointy-headed intellectuals” at universities. “There is no exploitable anomaly,” he maintained.

He and three other professors said academic studies dating to 1969 show that any gains to be had occur either a few days before or after the split announcement.

Nevertheless, Seiver did offer one useful suggestion: If you have tripled your money in a stock, sell a quarter of your shares before a split’s effective date as a discipline to take profits and re-balance your portfolio.

Street Strategies explores tactics that the nation’s savviest private and institutional investors use to maximize gains and minimize risk. Jon D. Markman is a Times staff writer. He can be reached at jon.markman@latimes.com

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Recent Splitters

Recent research indicates that investors can reap above-average returns by buying stocks after they split. Here are some stocks that split 3-2, 3-1 or 2-1 in the first half of November. Also shown are the stocks’ year-to-date gains and annualized earnings-per-share growth rates over the past five-years.

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Last Nov. 15 % Change 5 yr.EPS split Name Ticker price YTD growth 2-1 TSR TSRI 10.50 300 26% 2-1 ADC Telecomm. DCT 37.38 105 17 3-2 ITT Edu. Services ESI 22.00 101 35 2-1 Tellabs TLAB 43.00 100 64 3-2 Guilford Pharm. GLFD 17.13 62 NM 2-1 Acxiom ACXM 21.38 56 29 3-2 Sylvan Learning Sys. SLVN 29.75 50 NM 3-2 Nichols Research NRES 25.25 47 8 2-1 Security Dynamic SDTI 42.00 47 82 2-1 First USA FUS 31.75 43 138 2-1 Periphonics PERI 19.75 42 61 2-1 BGS Systems BGSS 25.50 38 9 2-1 Federal Express FDX 41.88 13 118 3-2 Southwest Bancshares SWBI 18.38 4 15 3-2 Belmont Homes BHIX 10.13 -16 80

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Source: Market Guide. Earnings growth rate excludes extraordinary items and discontinued operations over the last five years. Not calculated if there are insufficient data. NM indicates data is not meaningful.

To receive a monthly update of split announcements and effective dates, call S&P; Marketscope at (203) 323-4400; the charge is $20 per month for fax service or $10 per month for electronic mail.