Every time a company announces a stock split, we hear the same chorus of voices moaning that splits mean nothing to shareholders.
But in fact, they do.
What critics mean is that when a company splits a stock, it has the same price-earnings (P/E) valuation and the same earnings per market capitalization. The fundamentals of the business do not change.
Technically, they are right. But the actions are not driven solely by the cold logic of detractors. History shows that stock splits produce outperformance – both immediately and for up to a year. That’s why I like to see them in the names I suggest in my stock letter (link is in my bio, below).
Here are some recent examples that demonstrate short-term pop:
TeslaTSLA,
announced before the market opened on March 28 its intention to proceed with a stock split. Since Friday’s close, the stock is up 8.8% at the March 29 close, compared to 3.2% for the Nasdaq COMP,
and 1.9% for the S&P 500 SPX,
If it’s “nothing”, I take it.
Amazon.com AMZN,
announced a 20:1 stock split on March 9. As of March 29, the stock was up 21.5%, compared to 10.3% for the Nasdaq and 8.3% for the S&P 500. The split will be effective on June 3.
*GOOG Alphabet,
announced a 20:1 stock split on February 1. Its stock is up 8.3% versus 3.5% for the Nasdaq and 1.9% for the S&P 500. The pin will take effect July 15.
These are not just bizarre examples – and the effect lasts well over a few weeks. Since 1980, shares of companies that do stock splits have typically risen 25% a year later, compared to 9% for the overall market, according to recent Bank of America research. They also outperform at three and six months, as you can see on this chart.
Why split stocks outperform
There are two reasons why stocks that have been split outperform:
1. Investors view stock splits as a sign of management confidence. This is not out of place, as splits occur more often in stocks that have bullish momentum behind them. This momentum is usually caused by powerful trends within companies. The momentum just continues, after the split.
“Companies announcing spin-offs have generally experienced sustained market outperformance and expect that outperformance to continue,” Bank of America says. “The underlying strength of the business is the main driver of high prices.”
2. Splits increase liquidity by making stocks more accessible to a wider range of investors, which Amazon acknowledged when it announced its split. After the split, its shares will go to about $170 per share instead of $3,386. Not everyone has a brokerage account that offers partial stock purchases, although they are becoming increasingly common. Even stilted, Vanguard will announce the option shortly, a company source said.
Not all shares are equal
performance is not always positive after a split. Stocks are showing negative returns about 30% of the time 12 months later. But the gains are more frequent and larger than the losses, on average.
If you want to steer your portfolio towards stocks that could benefit from a stock split announcement, use these tactics. First, go for names that have high stock prices, of course, above $500. Next, favor names in consumer discretionary, technology and healthcare, where splits precede better results. Gains for these groups average 26% to 38% in the 12 months following the separate announcements. It is probably because these are sectors of growth and dynamism.
Unfortunately, stock split announcements have become increasingly rare over the past decade. There have been only 28 stock splits in the past five years, compared to 346 in the 1996-2000 period.
But that could change. Recent market rewards for spinoff announcements at top companies like Amazon, Alphabet and Tesla could encourage other companies and spark a wave of spinoffs, says Bank of America analyst Justin Post. Since splits attract capital inflows and support prices, they can be more beneficial to companies than more expensive share buybacks.
Five candidates for the stock split
In addition to owning Tesla, Amazon.com and Alphabet for more outperformance ahead, as indicated by their recent stock split news, consider owning or watching these names for potential split news. They all have high stock prices, good growth, decent market momentum, and Bank of America buy ratings.
NVRs: One of the largest home builders in the United States, NVR NVR,
manufactures single-family homes, townhouses and condominiums. NVR also has a mortgage banking and securities services business. I include recent or forecast trends in sales and earnings, to demonstrate the growth angle.
NVR posted 19% revenue gains last year to $8.95 billion and a 37% increase in net profit to $1.24 billion. Even if interest rates rise, demand for homes is expected to remain strong due to pent-up demand and tight supply. Shares of NVR are trading at $4,748 per share.
Reserve credits: This online travel company helps customers book flights, hotels, restaurants, cruises, tours and car rentals. BKNG Reservation,
is known for its user-friendly website and search functions. It operates under the Booking.com, Priceline, Agoda, Rentalcars.com, Kayak and OpenTable brands. All of this makes Booking a game of reopening as Covid continues to recede, which I think it will.
Gross travel bookings in the fourth quarter were up 160% year over year to $19 billion. Revenue rose 141% to $3 billion and net earnings per share were $14.94, compared to a diluted net loss per share of $4.02 a year earlier. Booking’s stock looks ripe for a split, as it’s priced around $2,370.
Transdigm: This company designs and sells proprietary high-tech aircraft components to aircraft manufacturers and airlines. It does a significant amount of repeat aftermarket business in the aftermarket business. TransDigm TMD,
typically sells higher-margin specialty parts like motors, batteries, throttles, and cockpit systems.
The company reported first-quarter sales growth of 8% to $1.2 billion. Net income from continuing operations rose 226% to $163 million, and posted earnings of $1.96 per share, compared with a loss of 42 cents per share a year earlier. Like Bookings, this is a re-opening coin given its exposure to the airline sector. At $684 per share, TransDigm stock looks set for a split.
Research: This company provides wafer fabrication equipment and related services to the semiconductor industry. Its products help chipmakers create better performing smartphones, personal computers, servers, wearables, cars and data storage devices.
Lam Research LRCX,
announced a 2% drop in sales to $4.23 billion in the fourth quarter and diluted earnings per share rose only 2% to $8.44. Like most chip companies, this one has been hit by supply chain issues.
But these will be resolved, putting Lam Research back on the path to growth. “We expect investment in wafer fabrication equipment to increase again in calendar year 2022, leading to another year of strong growth for Lam,” CEO Tim Archer said during the announcement. of the company’s results in January. The stock could use a split, since it costs $569.
ServiceNow: This company’s Now platform helps businesses, universities and governments work more efficiently by digitizing their workflows.
ServiceNow is NOW,
sales rose 29% last year to $5.9 billion, but earnings per share rose only 2.5% to $6.07 as the company continued to reinject money in the business. ServiceNow believes annual sales will grow by at least 20.5% over the next five years, reaching more than $15 billion in 2026. Its stock is expected to be split, as it trades at $598 per share.
Even if these companies do not split their shares, the stocks should do well due to the bullish end market trends.
Michael Brush is a columnist for CBS. At the time of publication, he owned TSLA, GOOGL and AMZN. Brush suggested TSLA, GOOGL, AMZN NVR, TDG and NOW in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.
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Opinion: Stock splits can be profitable for investors. Here are five companies that could do well if they split their shares. – CBS