Stock splits: the dog whistles from companies that coming news is constructive, even though splits don't change stock value.
Warren Buffett notoriously hates stock splits, considers them a waste of a company's time, and argues that he wants to partner with investors, not traders.Berkshire Hathaway (BRK.A) Class A shares trade at $218,000. True to his word, BRK.A has never split.
On the other hand, after introducing his Class B shares in 1996, which had one-thirtieth the value of the Class A, the "Baby Bs" split 50 for 1, meaning that shares have a value of one fifteen thousandth of its gargantuan sibling.
So why do investors react to stock splits as if, instead of two tens for a twenty, they're getting two tens for a five? "Stock splits are almost as good as insider trading," Neil Macneale, owner of 2 for 1, the stock split newsletter, and the 2 for 1 index, said in an interview. Companies that announce stock splits are blowing a dog whistle that savvy investors can hear, Macneale argued.
Research has shown that companies that split stocks outperform their peer group for a period of nine to 12 months. It isn't forever, but it's not day trading, either.
"There might be a credible signal about the company's prospects," David Ikenberry, dean of the Leeds School of Business at the University of Colorado at Boulder, who has studied stock splits extensively, said in an interview. "There's no economic causality in a split," Ikenbery added. "The company's tax situation doesn't change, its labor costs and its product marketing don't change.
"What changes is the way it's perceived by investors," he said. "There's signaling information accompanying the split."
In short, CEOs don't engineer stock splits if they're aware that bad news is around the bend. The corollary being that any coming revelations will be positive. And investors have interpreted those splits as a wink-wink, nudge-nudge that good news could be aborning.
There are some tangible - if marginal - benefits to a stock split. High priced stocks - think $100 plus per share - typically have a wider bid/ask spread. High priced stocks also capture, on a relative basis, more institutional money than from individual investors, who tend to resist high priced stocks on the perception that they're more expensive than low priced stocks. That's the "traders versus investors" dynamic that Buffett espouses.
High priced stocks can even be more susceptible to missteps in reporting quarterly earnings results. A company with a $150 price might be expected to report quarterly profits per share of, say, for the sake of argument, $1.50 a share.
Then say it reports $1.49 a share for the quarter. It goes down on the books as a "miss." Even though the extent of the "miss" amounts to a negligible 0.006%. That's effectively a rounding error, but it still gets recorded in the Wall Street ledger as an earnings shortfall. If the stock is cheaper - more like $15 a share - and the earnings forecasts are closer to 15 cents a share, a 0.006% shortfall means the company reports 15 cents a share. Which is, of course, not a miss.
Then there's the question of index eligibility. Remember, up until just over a year ago, Apple (AAPL) wasn't in the Dow Jones Industrial Average. It was widely assumed that a $700 a share stock, which is where Apple was trading until two years ago, wouldn't be considered for inclusion in the Dow Jones Industrial Average, largely because the stock would cause wild daily gyrations in the price weighted DJIA.
In June 2014, Apple split 7 for 1; by March of the following year, it was welcomed into the Dow.
Right now Priceline (PCLN) occupies the territory that Apple used to reside in: it's an unlikely candidate for admission into the Dow, with its shares trading at $1255. (Though, in an example of the law of big numbers, Priceline shares traded at nearly $1400 just a week ago.) Ditto for Alphabet (GOOG) , which is trading around $686 a share.
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"We're not going to shoehorn in a $700 stock," David Blitzer, director at Standard & Poor's and chair of the index committee, said in an interview. The industrial average likes to be maintained in such a manner that its highest priced stock and its lowest priced stock are trading at a roughly 10 to 1 ratio.
Which isn't to say the Dow doesn't have its share of high priced stocks. The highest priced stock in the Dow industrial average, 3M (MMM) , trades at $173 a share. Among the lowest priced stocks is General Electric (GE) , which trades at $31 a share. Currently, 3M has a 6.6% impact on the Dow industrial average, which is, again, price weighted. GE has a 1.2% effect. That means that on any given day, if 3M moves up or down by a dollar, the Dow moves nearly 7 points in that direction. While if GE moves one point, the Dow adds or declines just over 1 point. (And GE, with a market cap of $286 billion, is huge verses 3M, with its $104 billion market cap, showing how irrelevant the stock price is.)
An exclusion from the indexes can be a drain on liquidity. Products like the Dow industrial average and the S&P 500 are heavily leveraged to ETFs, a huge source of liquidity. And CEOs, in general, tend to like nice, liquid markets for their shares - it benefits what Wall Streeters call price discovery. (CEOs seemingly also like the virtues of high share prices. How can a chief executive be doing anything but a wonderful job if the market thinks the stock he's stewarding is worth $100 or more?)
And, as Ikenberry suggested, it's a lot easier to imagine that a $15 stock can climb to $20 in relatively short order than it might be for a $300 stock to get to $400.
Which isn't to say that popular indexes don't have high share prices. Of the Dow's 30 components, 11 have stock prices that top $100 a share. Within the S&P 500, more than one fifth of its components trade at triple digits.
That's a contravention of what would have been market conditions a generation ago. "Higher stock prices are more prevalent than they used to be," Blitzer said.
In fact, currently, the number of stock splits of S&P 500 companies is the lowest it has been in more than 15 years, Thomas Sutton, the editor of an investment newsletter called the RightLine Report, said in an interview. "For the last 15 or 16 years, we've seen a remarkable downtrend," Sutton said.
RightLine's bread and butter for the 20 years it has been published has been stock splits. The newsletter not only gave recommendations on stocks of companies that had announced or completed splits - remembering that the associated benefits of a split can last for up to a year - it also trafficked in predictions of companies that it thought could be a good candidate to split.
Lately, RightLine has found itself seeking new trading strategies. "We love splits," Sutton said. "There just aren't as many of them."
Well, The Street is throwing caution to the wind. We've identified five companies with share prices of more than $100 that could, arguably, benefit from splitting shares. We shied away from the Dow components with big price tags, as well as from the somewhat obvious targets, such as Priceline or Chipotle Mexican Grill(CMG) .
What we've come up with are five stocks that could benefit from the boost in liquidity that could come from making their share prices more attractive to individual investors. Coincidentally, each of these stocks is a brand that would be familiar to consumers, the "buy what you know" kinds of investors that are occasionally inclined to think, "I've enjoyed their product / service, maybe I should invest in the stock."
First up: Monster Beverage (MNST) . Shares trade in the neighborhood of $159, not far from the $160 52-week high reached in December. The maker of energy drinks has been a spectacular performer, returning something on the order of 500% the last five years, even though sales growth in that period has been a still impressive but not comparable 108%.
The bulge in the stock has been wonderful for Monster management. Its two top executives gained nearly $600 million in the last year from exercising stock options, a windfall that shows the unpredictability of remunerating bosses with stock.
Coca Cola (KO) was impressed enough with the company's product portfolio and merchandising effort that the soft drink giant took a 17% stake in Monster in 2014 for $2.2 billion.
Monster Beverage trades at a monstrous premium to its value, hoisting a forward P/E of more than 40 times. Daily average volume is a relatively robust 1.6 million shares, though the stock has been known to trade at four times that level.
And Monster Beverage isn't unaware of the stock split initiative, having orchestrated one in 2012, when it underwent a 2 for 1 split. Shares have nearly tripled since that split was undertaken. Meanwhile, Monster's predecessor company, known as Hansen Natural, undertook two splits a little more than a decade ago, including a 4 for 1 split in 2006.
(The company did not respond to our inquiries on the prospects of a stock split.)
Its daily trading volume amounts to a meek 300,000 shares, though volume of as much as 6 million in a day has been registered. The average daily trading volume would suggest that Cracker Barrel could benefit from the additional liquidity that a stock split would engender.
There's qualities to like about Cracker Barrel, foremost among them the solid yield - nearly 3% - as well as the company's reputation for shareholder friendliness. Earlier this month, the board approved a $3.25 special dividend.
Cracker Barrel has had extensive experience with stock splits, notching six of them in the company's history, though none in more than two decades. Its sixth split came in March 1993.
(The company did not respond to our inquiries regarding the prospect of a stock split.)
It says something about the law of big numbers that Boston Beer (SAM) could be 36% off its October high, and yet still trade at $166 a share. That's down, though, from its $260 a share price last fall. Still, the price of a share of stock might get you 25 pints of the Sam Adams maker's signature ale in your local pub.
The brewer has some distinctly light beer trading trends, with a daily average trading volume of just 163,000 shares; even when the stock is trading relatively briskly, it still struggles to achieve half a million shares in daily volume.
The maker of beer and cider products showed slippage in sales when it posted its first quarter results, and there are concerns that earnings may have peaked, leading to the pullback in the share price, two trends that argue against the prospect of a stock split. If there's bad news abrewing, management is likely to decline to undertake a stock split, according to conventional wisdom of managing stock value.
(Boston Beer pointed journalists to its published financial reports, which don't make mention of a stock split.)
J.M. Smucker (SJM) would seem to be a ripe candidate for a split: shares trade at a high of $151, and have delivered a 10 year return of more than 400%, including a 40% bulge off last summer's lows.
Average daily trading volume is just under 1 million shares, though that figure has been four times more robust in recent periods.
It's been fifteen years since the well known jelly maker orchestrated what seemed like a no-brainer product consolidation, buying Jif peanut butter (along with Crisco shortening) for $810 million, suggesting that every time you're fashioning a PB&J, there's a good chance you're digging into one or more Smucker products.
Smucker has no history of undertaking stock splits. The fundamental story, though, seems to be intact, with earnings the last four quarters handily beating forecasts and earnings estimates for the upcoming year rising among Wall Street analysts, suggesting there's no potholes that might prevent Smucker from doing something as shareholder friendly as making its stock price significantly cheaper.
(The company did not respond to requests for insights into its stock split plans, if any.)
Sherwin-Williams has had significant experience with the effects of a stock split, though not in nearly two decades. The company split its stock in April 1986, April 1991 and again in March 1997. In the ensuing 10 years, the stock has returned 630%.
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The trends in the company's core paint and wall coverings business have been robust, fueling the rally in the stock. Do-it-yourself paint products are selling at record levels, as the trends in home sales that occurred during the financial crisis has turned from a headwind to a tailwind for home repair and restoration products providers like Sherwin-Williams. Granted, DIY paint projects are a relatively small part of Sherwin-Williams sales. Nevertheless, input costs have turned lower, meaning margins are rising.
If there's a bustle in the hedgerow, from a stock split perspective, it's that Sherwin-Williams will be dealing with its $11 billion acquisition of paint maker Valspar, which could occupy enough of management's time to make initiatives like a stock split something of an afterthought. A spokesman for Sherwin-Williams said the company has no plans to split its stock.
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