MARK HULBERT

Splitsville

Commentary: Large number of stock splits not a worrisome sign for market

Last Update: 12:05 AM ET Jun 20, 2007

ANNANDALE, Va. (MarketWatch) -- Your mind hasn't been playing tricks on you.

It really is true that lots of stocks have undergone splits lately, or have announced that they will soon do so.

The Hulbert Financial Digest calculates that no fewer than 47 stocks on the New York or American stock exchanges or on Nasdaq's national market system have already split this month, or will do so in those few trading days that remain. An additional 33 did so in May. Both these monthly totals are the highest in a year.

Neil Macneale, editor of a newsletter that focuses on stock splits called the 2-for-1 Stock Split Newsletter, wrote earlier this week that this hot pace of stock splits "is as though we're back in the dot.com boom."

Macneale's allusion to the Internet bubble got me wondering if a fast pace of stock splits is indicative of an overheated market that will soon correct. So I gathered data on stock splits back to the early 1970s. I looked to see if there were any correlation between the trend in the number of companies splitting their stocks and the stock market's subsequent performance.

I did find such a correlation, but there is no need to worry: It turns out that an increase in the number of companies splitting shares is more likely to be followed by a stronger stock market than a weaker one, over periods as long as three subsequent years.

To be sure, the statistical basis for this correlation is not overwhelming. While statistically significant at the 95% confidence level, the correlation nevertheless explains no more than a small fraction of the stock market's subsequent return. (The highest r-squared in any of the tests I ran, for example, was 5%.)

Still, it is noteworthy that the correlation is positive, rather than negative. So even if you were to dismiss the significance of the positive correlation between stock split activity and subsequent stock market performance, you still would have no basis for concluding the large number of recent stock splits is bearish.

We probably should not be surprised by the positive correlation between stock splits and stock market returns, since several academic studies have found that stock splits are a positive omen for the companies undergoing those splits. One such study found that the average stock that splits its shares outperforms the market by 7.9 percent over the year following the split's announcement, and by 12.2 percent over the three years following that announcement. See study

Why should this be the case? Prof. Dave Ikenberry of the University of Illinois at Urbana-Champaign, one of the authors of this study, says that the answer may trace to a "sweet spot" in which the typical company likes to have its stock trade. Though that sweet spot is not precisely defined, companies will not split their shares, even if the prices of those shares have risen sharply, if management believes there is a significant probability that their prices will fall back into that range by themselves.

In effect, therefore, stock splits are a signal from management that they have confidence in the continued appreciation of their companies' shares.

This, after all, is the theoretical foundation of the stock picks included in Macneale's newsletter. And not surprisingly, those picks have done well.

According to the Hulbert Financial Digest's calculations, his model portfolio produced a 13.1% annualized return from November 1, 2000, to May 31, 2007, far outpacing the 3.1% annualized return over the same period for the Dow Jones Wilshire 5000 index (97199001

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The meaning of all those stock splits - MarketWatch

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