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Should Investors Buy a Stock After It Splits? — Journal Report

By Derek Horstmeyer 

In the past few months, numerous well-known companies have undergone stock splits, including Apple and Tesla.

In theory, a stock split shouldn't matter one bit for a company's future returns. Cutting the price per share of a company in half while doubling the number of shares outstanding changes nothing fundamental about the company, since its market capitalization is exactly the same as it was before.

But examining the full list of stock splits over the past 40 years highlights some interesting results. Overall, the stocks of companies that split their shares have significantly outperformed their benchmark over the subsequent months, earning an average of 1 percentage point more than the benchmark over the six months after the split.

Yet, there is one period when buying into a stock after it has split appears to go horribly wrong -- when exuberance among individual investors is high. In years when equity markets were on a tear, buying into a stock split cost an investor an average of more than 6 percentage points in lost returns, compared with the stock's benchmark, one year after the split.

Data since 1980

To undertake this study, Stephanie Fincher and Eric Dzik (research assistants at George Mason University) and I examined a total 3,480 stock splits and reverse stock splits since 1980 for U.S. stocks listed on the Nasdaq or NYSE. We looked at the one-month, six-month and 12-month returns for investors who bought stocks that had just split or been part of a reverse split.

Returns were measured against a portfolio of other U.S. stocks with similar market capitalization and book-to-market ratios.

We found that stocks returned 1 percentage point more than their benchmark, on average, over the six months after a split and 0.82 percentage point over 12 months.

But those averages disguise some big differences in certain years. We looked at years when stock ownership by individual investors was in the top 15% of yearly observations over the sample period -- 1998, 1999, 2007, 2018, 2019 and 2020. For these years, with equity markets calling all investing novices to come and buy in, we found that stocks' returns averaged 2.95 percentage points less than their benchmark in the six months after a split, and 6.12 percentage points less than their benchmark over 12 months.

Reverse stock splits

Also of interest are the results associated with reverse stock splits, when a company reduces the number of listed shares and increases the price per share.

Although these are much rarer than regular stock splits, there were 304 reverse splits since 1980 that we examined.

The message here for investors is clear: We found that stocks earned 1.18 percentage points less than their benchmark on average in the month after a reverse split, 7.57 percentage points less after six months and 12.02 percentage points less over 12 months.

So as an investor, it may very well be worth it to buy into a company that is splitting its stock, as long as individual investors aren't caught up in the hype and partying like it's 1999 -- or 2020. But if a stock you hold is reverse-split, this may be a sign that things are going to get way worse before they get better.

Dr. Horstmeyer is an associate professor of finance at George Mason University's Business School in Fairfax, Va. He can be reached at reports@wsj.com.

 

(END) Dow Jones Newswires

December 06, 2020 14:14 ET (19:14 GMT)

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