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WALL STREET, CALIFORNIA | STREET STRATEGIES / JON D.
MARKMAN

Split, and Take the Money

Investors can beat the market by pouncing when solid companies divide their stocks.

November 26, 1996|Jon D. Markman

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.)

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