Stocks are Fundamentally Changed When Split

Stocks are Fundamentally Changed When Split

Although, theoretically, splitting a stock should not change the way it trades, research has found that it does. This according to an article in

“Splitting fundamentally changes how stocks trade,” the article notes, adding, “That can make it cheaper for investors, improving their returns. In turn, when investor returns increase, stock valuations should outperform.”

The article outlines the following research findings on the topic:

Split stocks trade higher: Large cap stock that split tend to outperform the market by an average of 5% over the 12 months that follow, findings consistent with a 2009 study that found liquidity improvements after stock splits that served to reduce the companies’ cost of equity capital on average by 17.3% (2.4 percentage points) per year.

Trading gets easier for investors:  The article notes the following trends that resulted in lower trading costs, adding that “when costs go down, returns go up, and valuations increase:”

  • Spreads: improved by 22%, with 89% of stocks seeing better spreads.
  • Liquidity: Value traded increased 18%, with 70% of stocks seeing better liquidity.
  • Intraday volatility: reduced 3%, with 66% of stocks seeing lower volatility.

Stock price affects tradability: The article explains the nuance of market structure and trading rules with a discussion of the impact of tick sizes (the measure of the minimum upward or downward movement in the stock price) and round lots (100 shares) on a stock’s tradability. It argues, “even regulators are aware that high priced stocks are a problem for traders.”

The lack of stock splits is not normal: The article notes that “It would be easier for all traders if stocks traded with roughly the same prices,” noting that between 1930 to 2007, “ stock splits were so normal that stock prices held in a consistent range around $40 per share.” Before 2007, it was unusual for the S&P500 to have more than a few stocks over $100.” Note: now there more than 100—about a quarter of the index.

The article concludes that stock splits “fundamentally improve tradability and that boosts valuations,” adding, “given all the benefits, is that stocks splits have become so unpopular in just the last decade. Let’s hope that changes.”