Foolish Stock Splits Can Hurt

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Corporate management at times makes the mistake of excessively splitting its company's stock. This is sometimes done based upon questionable advice from the company's Wall Street investment bankers.

In rny opinion, it is usually better for a company to split its shares 2-' for-1 or 3-for-2, rather than 3-for-l or 5-for-l. (When a stock splits 2-for- 1, you get two shares for each one previously held, but the new shares sell for half the price.)

Overabundant stock splits create a substantially larger supply and may put a company in the more lethargic performance, or "big cap," status sooner.

It is particularly foolish for a company whose stock has gone up in price for a year or two to have an extravagant stock split near the end of a bull market or in the early stage of a bear market. Yet this is exactly what most corporations do.

They think the stock will attract more buyers if it sells for a cheaper price per  hare. This may occur, but may have the opposite result the company wants, particularly if it's the second split in the last couple of years. Knowledgeable professionals and a few shrewd traders will probably use the oversized split as an opportunity to sell into the obvious "good news" and excitement, and take their profits.

Many times a stock's price will top around the second or third time it splits. However, in the year preceding great price advances of the leading stocks, in performance, only 18% had splits.

Large holders who are thinking of selling might feel it easier to sell some of their 100,000 shares before the split takes effect than to have to sell 300,000 shares after a 3-for-l split. And smart short sellers (a rather infinitesimal group) pick on stocks that are beginning to falter after enormous price runups—three-, five-, and ten-fold increases—and which are heavily owned by funds. The funds could, after an unreasonable
stock split, find the number of their shares tripled, thereby dramatically increasing the potential number of shares for sale.