Friday, May 18, 2007

Stock Splits Are Likely to Decline in Frequency as Companies Favor Over $100 Priced Stocks

There is an interesting phenomenon in the financial markets which I believe will continue to gain traction and could have implications for investors for years to come. Now more than ever, companies are allowing their stock prices to trade and remain above $100 (or par) per share without splitting their shares to allow sub par prices.

For many years, I could only recall two companies which consistently had stocks which were priced above $100: Berkshire Hathaway (BRK/a, BRK/b) and Alleghany Corp (Y). Now I can name several of the core holdings for LakeView Asset Management, LLC which are above $100 with no indication that a split is forthcoming. These holdings are Google (GOOG), Sears Holdings (SHLD) and Goldman Sachs (GS). Many more companies are joining the ranks of over $100 priced stocks. With its recent move, Apple (AAPL) is well above $100 and despite the company having split its stock 2 for 1 on three occasions since 1987, I wonder whether AAPL will split its stock or become part of the new “century” stock issues.

While splitting a stock has no implication for an investor’s holdings or tax basis, it does have some secondary psychological effects upon investors and the markets. First, investors are trained to think in terms of round lots of shares 100, 200, etc. rather than dollar amounts when making an investment decision. Some investors would prefer buying 100 shares of a $45 stock than 1 share of a $450 stock such as GOOG even though GOOG is a better investment value than the other company’s stock. Second, bid / offer spreads will tend to widen in absolute terms but not in relative or percentage terms as the price rises. This becomes more apparent when the stock rises above $100. Third, the wider price swings in absolute terms for the century stocks will give an appearance of higher volatility and increased risk even though the price swings may be equivalent on a percentage basis. In other words, a $5 swing on a $150 stock seems more precipitous than a 50 cent move on a $15 stock. Finally, anyone who desires to enter into options related activity will require more capital since the minimum option contract for most stocks carries a multiplier of 100 shares per contract. This will scare away speculators and likely drive spreads and implied volatilities higher.

On the other hand there are some benefits to maintaining a high stock price and not splitting a stock. Higher stock prices will decrease speculative activity and likely keep shares in the hand of long term holders. Furthermore, higher stock prices can be excellent marketing tools for companies as the media attention that is paid to such issues provides greater brand recognition for a company and could enhance customer appeal.

I believe that we should expect to see an ever increasing population of stocks which will be trading above $100 in the years to come. This will be beneficial for long term shareholders but will require the undoing of a deeply rooted mindset that believes stock splits and lower stock prices are in investors’ best interests.

At the time of this Blog entry Scott Rothbort, his family and or clients of LakeView Asset Management, LLC were long shares of AAPL, GOOG, GS and SHLD -- although positions can change at any time.

1 comment:

Anonymous said...

You left out a very important point. A stock split creates huge transactional costs as US brokers usually charge a per share fee, not a % of the trade.