Don't Be Fooled By Stock-Split Mania LOOK FOR EARNINGS, NOT HYPE
By Herb Greenberg

(FORTUNE Magazine) – This split thing is getting way out of hand. Not long ago, in response to a reader who wanted to know if there was any Internet site that predicted stock splits, I wrote, "Not that I know of." Goes to show what I don't know. I got bombarded by readers giving me the name of a website that claims to know which companies will be next to split their stocks. The site--which I won't identify, on moral grounds--touts trading splits as "very profitable." It goes on to say: "We have a large, power-packed group of stocks we feel will announce splits very soon. Wouldn't you relish the idea of owning the stock before the split announcement?"

Oh, please! When the possibility of a split becomes the chief reason to buy a stock--so much so that investors wear beepers to alert them to splits--we're all in trouble. Splits, after all, began as a Wall Street gimmick to help individual investors avoid a penalty that brokers used to charge for "odd lot" purchases (fewer than 100 shares of a given stock). Companies like it when retail investors buy their stock, because individuals are generally considered more loyal than institutions, but the higher a company's stock price rises, the fewer individuals there are who can afford to buy a 100-share block. "American management discovered long ago that the average individual investor likes to buy stocks that trade at $40 per share," says veteran market pundit Bob Stovall, of Stovall/Twenty First Advisers. Hence, the urge to split.

But today the so-called "odd-lot differential" has disappeared, and individuals have become just as fickle as institutions. So stock splits are now often little more than hocus-pocus to trick unsophisticated investors into thinking they're getting a bargain when they really aren't--the Wall Street equivalent of pricing something at $19.99 instead of $20. In the most common of all splits, a two for one, one share at $50 becomes two shares at $25. Yet you're no wealthier than you were. The company's capitalization is no different than it was. Technically, nothing has changed except the perception that the stock has suddenly become cheap and affordable.

That perception, however, is very strong. Splits have become a "retail phenomenon," says Bill Meehan, chief market strategist at Cantor Fitzgerald. The number of New York Stock Exchange splits rose by 41%, to 235, between 1996 and 1997 and stayed at roughly the same volume in 1998. Last year, according to S&P, some companies even split their stocks twice. (Sorry, but nobody keeps statistics of Nasdaq splits, which is where much of the most questionable action has taken place, thanks to the insanity over Internet stocks.)

"People have always loved splits," says Joe Tigue, managing editor of Standard & Poor's The Outlook newsletter. Tigue says you really can predict stock splits, which is why his 80-year-old publication gets frequent requests to reprint its list of split candidates. "If a company has a history of splitting, and the price is where it was when the last split occurred, chances are it'll split again," he says.

In the past, in fact, stocks that split tended to go higher, according to S&P--but not because of the split: they went up because earnings were rising. (There was a time, in fact, when splits were always followed by a boost in a company's quarterly dividend.) "Earnings can be faked, they can be transient," Stovall says. "But dividends reflect real value." Without earnings and dividends, he adds, "all you're doing is fanning the speculative fires."

Which is what seems to be going on much of the time in today's split-crazy market. Stocks that are splitting often have no earnings momentum or even any earnings at all--Internet stocks being notable examples. And dividend increases have become very rare.

The final reason this split thing is getting out of control: While splits remain a hit with small investors, they've also become a favorite of the day-trading/momentum crowd, which bounces from one hot stock to another in search of anything that will produce a trade. The trend hasn't gone unnoticed by corporate executives, who are under pressure to manage the performance of their stocks. Notice that when Amazon.com's stock started to swoon back in November, the company announced a split. Never mind that it isn't expected to post a profit for another year or two. Amazon said the reason for the split was to increase liquidity by boosting the number of shares outstanding. And Amazon's stock immediately reversed itself and within weeks added more than 100 points as it crossed the $300 mark.

The stock-split mania isn't going to end anytime soon. If you find you're starting to believe the hype, ask yourself two questions: Why does Berkshire Hathaway trade above $60,000 per share, and why has it never split? The answer: Because Warren Buffett believes that over the long term, tricks don't necessarily make the best trade.

HERB GREENBERG is senior columnist for TheStreet.com (www.thestreet.com). His E-mail address is herb@thestreet.com.