Where Have all the Stock Splits Gone?

Stock splits, historically a bullish signal, have virtually dried up. Mark Hulbert explains why.
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Only two companies in the S&P 1500 index have announced stock splits so far in 2020, thereby sidelining a stock-picking tool that has an excellent long-term record.

I’m referring to the bullish signal a company sends when it announces that it will split its shares. Academic research as far back as the mid-1990s documented that such stocks, on average, outperform the market for up to three years after such announcements. This research in turn spawned an investment newsletter, the 2-for-1 Stock Split Newsletter, edited by Neil MacNeale, which has handily beat the market over the past three decades.

MacNeale’s approach is dependent on there being a regular supply of stock splits. Each month he adds to his model portfolio a stock that has recently split its shares, and he holds that stock for exactly 30 months. Last week he wrote to clients to say, “because of the lack of split announcements, our ability to ferret out the future winners from the rest of the market has been greatly diminished.”

Before discussing why the number of splits has been falling, it’s helpful to step back and review why a stock split historically was a bullish signal: It’s because companies were catering to retail investors who didn’t want to buy a stock whose price was too high. They therefore had a loosely-defined “sweet spot” in which they wanted their shares to trade. When a stock traded well above that range and the company didn’t believe the stock would fall back into that range on its own, the board would consider a share split.

The pandemic-induced bear market is of course one reason why there have been so few splits so far this year. Between the market’s high on Feb. 19 and its low on March 23, many stocks dropped by just as much as they otherwise would have had they undergone a 2-for-1 split. It makes sense that any companies that previously had been contemplating a split would put their plans on hold.

But the bear market doesn’t deserve all the blame. Given the market’s impressive rally since its March 23 lows, nearly 200 hundred of the stocks in the S&P 1500 index are now trading within shouting distance of their 52-week highs. (I defined this as trading within less than 10% of their 52-week highs.) So, if there weren’t some other factors at work, you’d expect to see more splits.

Further evidence that there must be these other factors is that the decline in split frequency doesn’t just date until the beginning of this pandemic. It instead has been going on for years. Between 2011 and 2019, in fact, the number of forward splits among the S&P 1500 stocks dropped by more than 75%, even as the stock market as a whole was tripling.

What might those other factors be? One is the growing dominance of the market by institutional investors who couldn’t care less about a sweet spot that is otherwise important to retail investors.

Another factor is the growing ability of retail investors to purchase fractional shares: Fidelity Investments announced in January that it would allow clients to buy fractional shares of stocks and ETFs, and Schwab is inaugurating a similar program in June. These changes mean that even retail investors may stop caring as much how expensive a stock’s price might be.

In an email, MacNeale suggested yet more factors over the years that may also have contributed to the long-term downtrend in the number of splits, such as the end of the odd lot trading expense and the near elimination of stock commissions.

He added that, in any case, corporate insiders appear to have shifted their focus away from what’s good for shareholders to a more short-term preoccupation with increasing the value of their stock and option holdings. “Instead of the simple signal that ‘the future is bright’ implied by a stock split…, boards now seem to be concentrating on buybacks and stock options.”

These changes don’t mean that stock splits have completely stopped providing the bullish signal they once did. As you can see from the accompanying chart, MacNeale’s long-term track record remains excellent. But it may mean that he will have fewer and fewer stocks to choose from each month.

Hulbert Chart 052620

(Full disclosure: MacNeale’s newsletter is not one of those that pays my firm a flat fee to audit its returns. The track record reported in this column and the accompanying chart are based an index calculated by NYSE Euronext.)