Splitsville

 Splitsville

How does a stock split typically affect stock performance? It depends. In principle, a stock split does not add any intrinsic value. A stock split simply increases the number of existing shares while simultaneously reducing the corresponding price point. So on the surface a stock split is a neutral event at best. So why would a company bother?

There are several important reasons to consider doing a stock split, some are purely aesthetic while others have significant value. First, from an aesthetic standpoint who doesn't like having MORE of something? Shareholders generally like the idea of having MORE shares. High flying stock prices make significant share volume purchases pricey, so companies feel that increasing the number of shares via a split will attract a larger base of potential investors (similar to the pricing of IPOs...rarely, if ever, do you see an IPO issue in the hundred dollar plus column; issuers want to generate enthusiasm for a deal by pricing MANY shares in the teens rather then far few shares in the hundreds of dollars.)

A second aesthetic reason for splitting a stock is to smooth the chart. Stocks that have literally gone through the roof have a parabolic chart that often suspiciously looks like it will collapse. Hence, we see splits to help smooth this 3, 5, 10-year chart to something approximating a ramp rather than a rocket ship launch.

The third aesthetic reason, but also a practical one, is the ability with greater volume of stock to better hedge positions via Covered Calls or Puts. Contracts are traded in 100 share units, thus for several big tech companies an investor would have to own several hundred thousand dollars worth of the stock just to have enough shares for a single options contract.

Aesthetic reasons aside, several large tech companies have announced share splits that will effectively transform their shares from several thousand dollars each into several hundred dollars each. Why does this matter? Potential inclusion into the Dow Jones Industrial Average hinges on share price rather than market cap. Currently three large tech companies come to mind that are NOT included in the DJIA. Significant splits make the eligible.

In summary, stocks split for many reasons. It has often been a litmus test of a company's success as to whether they do split or not. One of my favorite websites is: www.stocksplithistory.com

Here a financial farmer can input a ticker symbol and get the historical stock split history of a company, resulting shares, and it also provides recent 10-year data of the hypothetical $10K invested in a company. Great financial tool!

Splitsville?

Follow the dancing ball…and three 2-1 splits later and you now have 8 times the number of shares originally owned! As a quick, and hopefully meaningful post, I have noticed a significant bullish trend developing. There are now a tremendous number of S&P 500 companies approaching levels where they have historically either performed a 2:1 or 3:2 split. This seems to lend credence to my hypothesis of hitting Dow 20,000 by December 31st, 2016. It is time for investors to embrace Log Base 2 (chart above.)

A quick review of the S&P 500 component list will quickly identify multiple candidates for potential splits, the vast majority of which haven't had a stock split in 10-14 years. Along with higher profits and increasing quarterly dividends, a great additional barometer is an equity's share price in relation to its last split. As many equities hit or are near their all-time highs, this litmus test should prove profitable to financial farmers.

If history is any indicator, those who wish to Invest Like A Farmer should see considerable split action in many of their high-quality, high-priced stocks in the next 18-24 months as the Dow Jones Industrial Average is driven higher due to continued easy money, increased corporate earnings, and stabilization of the housing market. Couple all of this with a backdrop of a considerably stronger employment picture, and I think Dow 20,000 should become a reality by the end of 2016.

High-Priced or Low-Priced Stocks?

All things being equal, I prefer high-priced stocks with few exceptions. While this may run contrary to popular thinking, as a financial farmer I prefer to own fewer shares of a company I deem to be a better potential investment than many shares of a less-promising investment.

There are several advantages to owning shares of high-priced stocks, although there is one significant disadvantage; the higher the price, the more room it has to fall. I've seen this scenario play out during several sell-offs over the years, where the point drop in high-priced securities typically falls more on a percentage basis than low-priced stocks. That is a risk of high-priced stocks, there is plenty of air between the top and the ground! With that caveat though, there are several good reasons to consider purchasing high-priced stocks over low-priced stocks.

High-priced stock, by definition, is priced higher than low-priced stock, and while intrinsically this might sound ridiculous, it actually points to several operations going on outside our normal purview. Generally speaking, there are less shares of high-priced stocks (which I consider an advantage for investors, as we want to own a larger and larger piece of the pie as time goes on) and consequently when you choose to Invest Like A Farmer you are very selective when deploying your seed capital into a handful of carefully researched positions rather then just throwing seeds into the wind and hoping for a winner by chance.

High-priced stocks also play on a theme we have discussed previously, namely momentum. Another seemingly unrelated occurrence begins to happen as a stock appreciates in price; more money is drawn to it. Everyone likes a winner, and there is no truer winner than a stock that keeps a steadily increasing left to right chart. This momentum often leads to one of my favorite events; a stock split!

Although a stock split actually decreases that high-priced stock's numeric standing, it also helps prevent a chart from going exponential, releases some of the pent-up momentum by providing additional shares to fill demand, and, also by definition, increases the share count which typically increases the pool of shareholders. So even though a high-priced stock may do a 2:1 split, say from 200 to 100, it is still priced above 80% of all other securities (the average S&P 500 stock price as of this blog post is about $70/share.)

Ideally, the financial farmer uses his or her seed money to purchase several handfuls of quality seeds that eventually spawn seeds of their own, pay the farmer to own them the entire growing cycle, and wealth is compounded. A high-priced stock "helps" concentrate wealth, causing the investor to focus on several potential successful business models rather than showering the fields with dozens upon dozens of cheap seeds; we want viable crops quarter after quarter, not weeds.