Ciena Shows Investors Still Go Bananas for Splits

Somewhere, someplace last weekend, a young man received a check for $150 for his birthday or his bar mitzvah or his confirmation from his rich uncle. And the lad knew exactly what he would do with it: Buy one share of Ciena (CIEN - Cramer's Take - Stockpickr).

Alas, he couldn't -- shares of the optical networker had risen above 150 last week, and on Monday they continued to rise. But fortunately for the youngster, somebody at the company was listening, and after the close Tuesday Ciena announced it would split its stock 2 for 1 on Sept. 18. Patrick Nettles, the company's president and CEO, said in a press release, "With six consecutive quarters of revenue growth and a share price which has increased more than fourfold in a year, a stock split will allow a broader base of investors to participate in this strong business momentum."

Warms your heart, don't it?

Stock splits do not, of course, make any fundamental difference to a company. Revenue, earnings, growth -- all those things you're supposed to use to determine an appropriate price for a stock -- aren't affected. And yet again and again, when stocks split, they tend to outperform the market. Some investors have even come to buy stock in hope of a split: Ciena's message boards have been awash with split speculation for several weeks now.

Split Decision Ciena Tuesday and Wednesday

Source: BigCharts

And though plenty of people scoff at buying into a stock on a split, Merrill Lynch's derivatives group, when it looked at splits a while back, found that they were "positive after the fact," according to equity derivatives analyst Steve Kim.

Kim speculates that splits may send stocks higher because of a "signaling" effect. "There's that vote of confidence from the guys managing the company, and then investors get optimistic," he says.

Confidence Man?

"It sort of leads you to believe that management is extremely confident going forward," agrees Brian Finnerty, head of trading at C.E. Unterberg Towbin. "Ciena couldn't have split their stock when everybody hated it" in the latter half of 1998, when it fell as much as 90%, as TheStreet.com documented. Ciena is scheduled to report fiscal third-quarter earnings Thursday. That management announced a split just two days ahead of the release suggests that the numbers will come in quite well. (TSC also took note of the Linthicum, Md.-based optical-network-component supplier's prospects in a piece two weeks ago.)

Long Climb Back Ciena recovers from deep 1998 slide

Source: BigCharts

Splits may also help in less tangible ways. "My guess is that they increase retail participation and daytrading participation," says Kim. "Those are more anecdotal -- we haven't been able to quantify it."

After rising as much as 3 1/2 in early trading Wednesday, Ciena was off 5 1/2, or 3.2%, to 164 1/2. So if splits are such a good thing, why the decline? Perhaps because investors speculating about a split leading up to the announcement chose to sell on the news. And perhaps word of the split got out a little early -- Ciena shot up 5 5/16 in the last 20 minutes of trading yesterday (see top chart).

Note to our young friend getting started in investing: Nobody said the stock market was fair.