Foolish Four Portfolio
Here a Split, There a Split...

By Ethan Haskel (TMF Cormend)

BALTIMORE, MD (Sept. 15, 1999) -- Help! It's been about a month since I started looking at stock splits, specifically how they might affect Foolish Four and Beating the S&P (BSP) investors. Since then, stock splits have filled my leisure hours, penetrated my subconscious, infiltrated my ego and id. Splits, splits, and more splits. When will the madness end?

Hopefully, today -- but not before taking a look at some interesting data regarding the performance of Dow stocks in relation to stock splits. Recall that last week we found that those Foolish Four and classic Beating the Dow stocks that split their shares in the previous year performed abysmally. In fact, 12 of 13 of these companies identified since 1961 had underperformed the S&P 500, often by large margins. A similar group of BSP stocks performed just as poorly, with 10 of 11 losing out to the market.

Can we generalize these results to all Dow stocks? Should investors avoid any Dow company whose stock had split within the past year?

To answer this question, let's look at the performance of all Dow stocks that split the previous year. As usual, we clicked open our handy-dandy Dow Dividend Spreadsheet to find all the Dow stocks since 1961 that had split. There were 87 in all. How did they perform the following calendar year?

Of all 87 Dow stocks that had split the previous year, 51 (or 59%) underperformed the S&P 500 average for the comparison year. The average Dow-splitter underperformed the S&P by 2.3%. A mediocre performance at best.

We already know that 13 of these 87 stocks were Foolish Four or classic Beating the Dow (BTD) stocks whose return averaged a paltry 8.1% for the years in question, underperforming the S&P 500 by over 15% on average each year.

If we remove our 13 Foolish Four/BTD stocks from the 87 Dow stocks that had split the previous year, we find ourselves with a slightly smaller group of 74 stocks. It turns out that the average return of these 74 stocks was virtually identical to the S&P comparison group.

Summary:

                            % difference    # under-
     Stock Group     (No.)  from S&P 500  performing S&P (%)
All studied stocks   (87)      -2.3%         51 (59%)
Foolish Four or BTD  (13)     -15.5%         12 (92%)
Non-Foolish Four/BTD (74)      +0.1%         39 (53%)
As a group, the Dow stocks that did the splits tended to underperform the market by a small amount. Just about all this underperformance can be accounted for by a small subgroup of stocks, those with high yields, the same stocks picked by the Foolish Four and Beating the Dow. When these stocks are factored out, the performance of the remaining Dow stocks is very close to that of the S&P 500.

What accounts for this apparent dichotomy between our Foolish Four stocks and the others? I don't know for sure, but I suspect it has something to do with the business models of the companies that are splitting. The Dow Dividend stocks that split have a strong tendency to be in cyclical businesses -- oil, metals, automobiles, chemicals. Instead of straight line, upward growth in earnings, their income and thus their stock prices fluctuate, each according to its own business cycle.

Since companies usually announce splits when their stock price is reaching new highs, the announcement may be timed to coincide with the peak of the company's cycle -- precisely the worst time when value-oriented Fools like us look to buy a stock.

Dow stocks whose earnings are more steady (for instance those selling pharmaceuticals, consumer staples, and tobacco) might not have such cyclical peaks and troughs. A stock split for these companies may truly portend better earnings growth ahead.

The following table shows the performance of Dow companies that have split frequently, grouped as steady earners or cyclicals. The first five represent the "steadies," while the last four are in cyclical businesses. I calculated the average stock performance the year following the split, compared with the S&P 500
                          No. times   Ave. % dif. 
  Steady stocks             split       from S&P   
Coca Cola <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KO)") else Response.Write("(NYSE: KO)") end if %>          3        +14.4%
Eastman Kodak <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EK)") else Response.Write("(NYSE: EK)") end if %>      4         +8.8%
Merck <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MRK)") else Response.Write("(NYSE: MRK)") end if %>             3         +3.0%
Philip Morris <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MO)") else Response.Write("(NYSE: MO)") end if %>      3         11.6%
Procter & Gamble <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PG)") else Response.Write("(NYSE: PG)") end if %>   6          3.3%

                       No. times    Ave. % dif. 
  Cyclical stocks         split      from S&P   
Alcoa  <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AA)") else Response.Write("(NYSE: AA)") end if %>          3          -1.4%
DuPont <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DD)") else Response.Write("(NYSE: DD)") end if %>          3         -17.3%
Exxon <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: XON)") else Response.Write("(NYSE: XON)") end if %>          4          -7.5%
Texaco <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TX)") else Response.Write("(NYSE: TX)") end if %>          4          -3.8%

Our cyclical companies have all done worse than the market in the year following the split, while the more steady growers have all outperformed. Hmmm....

After four weeks of splitting madness, what conclusions can we reach? It seems reasonable to conclude that large, high-yielding companies included in the Foolish Four or BSP portfolios just don't perform up to our expectations after their stocks split. As for the rest of the Dow stocks, a stock split has no effect on the stock's subsequent performance.

I promise that's the last you'll hear on the topic of stock splits -- for at least a week or so. This column's running a bit long anyway, and there's work to be done around the house.

Gotta split!

[Editor's Note: Following are the returns of a "paper" Beating the S&P portfolio. The stocks were selected December 31, 1998, and "purchased" in equal dollar amounts to be "held" for one year. To see a list of stocks for portfolios starting now, see Today's Stock Lists. Note that the stock split change has not yet been incorporated into this format.]
Beating the S&P year-to-date returns (as of 09-14-99):
Schlumberger <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLB)") else Response.Write("(NYSE: SLB)") end if %>      +43.8%
Kimberly-Clark <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KMB)") else Response.Write("(NYSE: KMB)") end if %>     +3.5%
Campbell Soup <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPB)") else Response.Write("(NYSE: CPB)") end if %>     -24.6%
Ford Motor Co.  <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %>     -10.4%
Bank of America  <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %>   -3.8%
Beating the S&P                +1.7%
Standard & Poor's 500 Index    +8.7%

Compound Annual Growth Rate from 1-2-87:
Beating the S&P               +24.9%
S&P 500                       +17.5%

$10,000 invested on 1-2-87 now equals:
Beating the S&P             $166,900
S&P 500                      $77,400

Today's Stock Lists | 1999 Dow Returns