Seeking Alpha From Stock Splits

Abstract

The authors assess the announcement trading returns on the stocks of splitting firms. The authors join the traditional cumulative abnormal return (CAR) approach to estimating abnormal returns with the economic value-added (EVA) style approach to investing. The authors’ empirical results are robust for a sample of more than 4,900 stock splits during the 1997–2014 period. The authors argue that alpha returns may be available by longing the stocks of splitting firms at the announcement and holding the trading position open for 5- to 10-trading days thereafter. A notable finding linked to EVA style is that alpha returns were available by longing the stocks of value-creating growth companies and the underinvesting but still positive EVA companies in need of a growth signal. This contrasts with the stocks of value-destroying growth companies where potential shorting opportunities were available. The authors conclude with CAR results for companies having a one-time stock split versus companies with repeat splits, and the authors assess announcement wealth effects on splitting firms around pre- and postdecimalization of US equity prices.

TOPICS: Security analysis and valuation, performance measurement, indexing exchange-traded

Key Findings

• • Our CAR and EVA style findings on stock-splitting firms confirm both information signaling at time of split announcement and the potential for alpha-generating trading returns thereafter.

• • For active investors, alpha-generating trading opportunities may be available by longing the stocks of splitting firms at announcement and holding the position open for some 5- to 10-trading days, with potential shorting opportunities on splitting firms thereafter (default event trading window of 30 days).

• • Based on EVA style classifications, we find that alpha-generating trading returns on stock splitting firms were potentially available on stocks of value-creating growth companies with positive EVA momentum and the stocks of currently underinvesting but still positive EVA companies in need of a growth signal.