Are stock splits good for investors?

stock-split

Dollarama recently posted another strong quarter. In addition to the quarterly results, the company also announced the proposal of a stock split in the ratio 1: 3. Dollarama shareholders can expect to receive two additional shares for each stock they own. According to the press release, only “shareholders registered at the close of business on 14 June 2018 are entitled to receive the two additional shares”. Does a split benefit the investors?

There is a major reason why companies are executing stock splits to improve liquidity. If the stock price of a company becomes too high for smaller investors, or if it is significantly higher than that of its competitors, a stock split leads to an impairment of the company’s share price. Therefore, a split can have the psychological effect of making the company more affordable for smaller investors, who in turn should buy more shares.

A study examining the 30 largest US companies in terms of market capitalization that conducted a stock split between 2001 and 2010 revealed no significant benefit. Exactly half of the companies achieved a positive return over a period of one year after the split and the other half a negative one.

Between 2015 and 2017, there were very few large companies listed on the TSX that carried out stock splits. Andrew Peller (WKN: A0LCR6) was split on 17 October 2016 at a ratio of 1: 3. In the following year, the share gained 4.65% and thus developed weaker than the market. On May 13, 2015, Brookfield Asset Management (WKN: A0HNRY) was split 3: 2. Brookfield also outperformed the market and returned only 0.14% year-on-year. On 6 April 2015, the Keyera (WKN: A1H5DU) was split at a ratio of 1: 2. Did the company beat the market? No. Unfortunately, the Keyera share lost around 16% of its value in the following year.

Crucial for investors is that a stock split has no significant impact on the financial position of the company. The underlying value remains unchanged. There is a common misconception that a split leads to a price increase due to increased liquidity. However, there is little evidence to support this idea. A stock split should actually be a neutral event.

Do not chase after stock splits
Although they may be tempting, stock splits are neutral events that serve primarily as a distraction. Investors should always be careful to invest in a company with solid fundamentals. Do not be tempted to chase meaningless events.

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