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Splitting hairs in splitting shares

By Dr. Don Taylor · Bankrate.com
Monday, December 30, 2013
Posted: 6 am ET

MasterCard announced a 10-for-1 stock split in mid-December, effective Jan. 9, 2014, and investors went wild, raising a stock price that was already up 55.43 percent year to date another 3.53 percent on the news. Through Dec. 24, the stock is up 65.5 percent year to date and 6.5 percent since the news.

Finance professors will tell you that a stock split by itself doesn't convey any news about the company, and a stock split should just reflect the change in shares outstanding. For example, an $800 stock that splits 10:1 should trade at $80 after the split.

Warren Buffet's Berkshire Hathaway Corp. has famously refused to split its shares, and a single Class A share sells, at this writing, for $176,010 per share, although its Class B shares are a more affordable $117.43 per share and did split in 2010.

MasterCard's decision to split the stock was combined with other announcements that it plans to raise its quarterly dividend and start a $3.5 billion share-buyback program. Both of these announcements have a positive impact on the firm's valuation.

Companies split their shares for a host of reasons. MasterCard was on its way to becoming a $1,000-per-share stock like Priceline and Google. Splitting the shares can make the stock more liquid, bringing the stock back into a more affordable trading range.

Speaking of liquidity, MasterCard's share-buyback program and 83 percent increase in its dividend will reduce excess cash held by the firm. Too much cash can be a drag on a stock's return. While stock buybacks can be a signal that the management team thinks the stock is undervalued or cheap, it also can signal that the company doesn't have any current capital expansion plans that require equity funds for investment. Raising the stock dividend also can signal that the money isn't needed for expansion.

Billionaire investor Carl Icahn has been a shareholder activist in trying to get Apple to increase buybacks and dividends to return cash to its shareholders. Apple has financed some of the expense associated with dividends and share buybacks in the past to avoid repatriating foreign earnings which would require it to pay U.S. taxes on those earnings.

Companies can do reverse splits, too. These happen primarily to raise the price of the shares. Citibank, trading below $5 per share after the 2008 financial crisis, did a 1-for-10 reverse split in 2011 to raise its share price. It also reinstated a quarterly dividend. Both steps made the stock more attractive to institutional investors.

The bottom line is that stock splits on their own don't do much for the company's stock valuation. It's the related news that moves the needle on valuing the firm's future prospects.

What do you think about investing in stocks that are scheduled to split?

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2 Comments
Dr Don Taylor
January 02, 2014 at 11:31 am

While you're right that a $1 move in MasterCard stock post-split is ten times more valuable than a $1 move in the pre-split stock.
It's because a $1 move in the MasterCard post-split is the same as a $10 move pre-split.

joe
December 31, 2013 at 2:34 pm

We own some Mastercard and have heard all splitting of a stock does is divide it by two on a 2?1 split. I .ve never heard anything about looking at it this way, on the 10/1 split a $1.00 increase in the stock price is larger for each one of the new stocks going forward than $1.00 on the old stock.

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