Rule Breaker Portfolio

<THE RULE BREAKER PORTFOLIO>

Stock Splits
"Should I eat the pizza before it's been sliced?"

By David Gardner (DavidG@fool.com)

ALEXANDRIA, VA (Feb. 24, 1999) -- "When do you think RuleBreakerStock.com will split?"

The question is everywhere: at cocktail parties, on our message boards, in the subway, on the radio. Ubiquitous. It is asked by people who actually mean, when you boil it down to the subtext, "Do you think RuleBreakerStock.com [a generic stock I'm making up] will go up?"

That's what they mean.

For them -- for many people -- asking when and if a stock will split is synonymous with asking if the stock is going to rise, is going to be a good investment. And yet there is virtually no connection, and certainly no guarantee. Asking if a stock will split is NOT asking if it's going to be a good stock. For this reason, I consider stock splits to be THE MOST OVERRATED TOPIC in equity investing today. And that's why they're worth talking about tonight.

But before we get too deep into it, we must note that the Rule Breaker Portfolio lost 1.84% of its value today, roughly comparable to the S&P 500 and Nasdaq, which were down 1.40% and 1.56%, respectively. We spent most of the day up a couple of percentage points before a significant afternoon sell-off. It was one of those days where we lost on every single investment; our only stock that rose was our short sale of Trump Hotels & Casino Resorts (NYSE: DJT), which means we lost money there, too.

For the year, we remain in the driver's seat, ahead of both indices by a few percentage points.

Some news to report: Late in the day Amazon.com (Nasdaq: AMZN) announced it has purchased half of Drugstore.com, and will put Drugstore.com on its main page starting as early as tomorrow. Drugstore.com, another Kleiner Perkins/Howard Schultz of Starbucks special, will soon begin competing in the $150 billion industry for retail healthcare, vitamin, and beauty products with its e-commerce offering. Join us in our Amazon.com message board for more discussion tonight.

Back to splits... and speaking of Starbucks -- Starbucks is only our latest example of a splitting Rule Breaker. This portfolio has seen past splits in America Online numerous times, Amazon.com, Iomega, Amgen coming up at the end of this week, etc., and now Starbucks (a 2-for-1, announced yesterday).

So that we're all really clear on this, let me give you the Foolish explanation of stock splits once again. Companies simply decide from time to time to reduce their share price and increase their number of shares available so that, as an example, they'll issue a 2-for-1 split that halves their share price and doubles their shares outstanding.

No change in value.

The "market capitalization" (the company's total value) of a stock is simply the shares outstanding multiplied by the share price. Thus, if you split the stock, you simply have that many more shares and that much lower (proportionately lower) of a share price.

No change in value.

Over the course of the 20th century, investors have somehow become increasingly conditioned to think that having more shares is somehow better -- and, conversely, that having a higher share price is somehow worse. Nay! Two of the best-performing stocks over the past 30 years are Wal-Mart and Berkshire Hathaway. One split numerous times, the other never has. Both HUGE. It's about companies, not stock prices.

Why do companies split their stock? Well, the conventional explanation is that they want to have lower share prices in order to attract a wider group of shareholders. The idea is that not as many people can afford to buy shares of Starbucks at $53, as can afford to buy it at $26 1/2. So SBUX management says, "Split."

OK, OK, but is this really significant? Buying odd lots (3 shares versus, say, 100 shares) is no longer a significant penalty or a difficult thing to do. So this whole "keep-the-share-price-smaller-for-the-little-guy" idea doesn't convince me. This, from many companies who still won't even let the little guy in on their conference calls?

Sure, sure. People with very little money -- the people that would supposedly be "priced out" of a higher-priced stock -- make up an irrelevant percentage of capitalization for most public companies. Obviously, I write that from a belief that shareholding should be consumer-based, mass-market-driven, and democratized, and I do believe in time that it WILL, and that The Motley Fool will continue to be the leader in democratizing the markets. But few people who are investing can't afford a share of Starbucks at $53. (Yes, I know other companies have $300 share prices -- though only a tiny percentage of those that actually split their stock, which are the ones I'm talking about.)

Anyway, I find it much more likely that the phrase "stock split" has a wonderfully positive connotation -- it's a phrase with BUZZ -- and that companies want to associate their equity ownership with that buzz. We all know that most great stocks have been around a long time, and have from time to time split their stocks, so that many studies wind up showing that companies that split their stocks -- stocks that get split -- do better than ones that don't. But this is a rather misleading, backward-looking argument: It's rather like arguing that companies that succeed happen to use new technology, simply because the ones that aren't around anymore can't obviously use that new technology! It's a tautology. This is about correlation, not causation.

OK, let me pull us back from the precipice of too much deep thinking on this topic. (Though please do join us, as ever, on the Rule Breaker Portfolio message board for more thoughts on the subject.)

There IS actually one dependable and good reason why companies splitting their stocks is bullish, but it's a reason you don't see written about in the popular press. Here it is: Consider that NO good company wants its stock to decline below $10 a share, as it tends to fall off the institutional buying radar. Thus, any company that splits its stock is willingly putting its shares in more jeopardy, by dropping them closer to that danger level. In this way, the company is effectively saying, "Things are looking good enough to split our stock. We the management are confident enough in our business's near-term prospects to drop our shares nearer that danger level." This is the only argument, to my way of thinking, that explains why stock splits are bullish. It doesn't always work (ouch, Iomega), but it does play out frequently enough to be pretty reliable.

But I hesitated even writing that, because my overall point tonight is that investors everywhere are way too jazzed, way too fired up, about stock splits, to the point that they risk being cynically manipulated by companies with more dubious prospects that split their stocks simply to juice speculative buying. When I find out there are sites wholly dedicated to tracking split stocks -- when I find out there are people who have their pagers set to let them know which stocks are splitting and when -- when I hear investment strategies tossed out like "Oh yeah, you just buy before the split, get that bump up, and then sell," I'm convinced I'm seeing spotty short-term speculative buying of a sort that will never be sustainable, and will eventually redound back upon its practitioners. No gloom-and-doom forecasts, here. I do not believe the Internet is a bubble, or the Y2K "bug" is going to crash society. I do believe this form of "investing" will ultimately burn those who focus on it.

But hey, to close on the ironic note we began with: "When do you think RuleBreakerStock.com will split?"

And, should I eat the pizza before or after it's been sliced?

Tonight, we've started a new message board: Stock Splits. If you've found our message boards a bit cluttered by discussions on the topic, just point posters to that message board, and keep the existing stock boards on topic. And as with most money subjects, we have a Motley Fool Frequently Asked Questions (FAQ) doc on the subject. Click here.

Good to be back from the book tour!

Fool Short Shorts: A superb article on the future of e-commerce. Fools are Dueling on the subject of Wal-Mart! And finally, read today's Fribble. It's a quick read every day from a member of the Fool Community, and today's is entitled "Too Much of a Good Thing". Jeff Campbell asks, "Are you addicted to The Motley Fool?"

-- David Gardner, February 24, 1999

P.S. Looks like we've landed The Beverly Hillbillies' Jethro this weekend, on The Motley Fool Radio Show...

Check out what's happening with Harry Jones today.

02/24/99 Close
Stock  Change    Bid 
 ---------------- 
AMZN  -4 1/4  110.94
AMGN  -1 7/8  127.00
AOL   -  2/3   87.50
ATHM  -3 1/16 106.00
DJT   +  1/16   4.31
CHV   -  7/16  78.31
CAT   -  15/16 46.00
DD    -  1/4   53.25
GT    -  7/8   47.19
IOM   -  3/16   6.31
SBUX  -  3/8   52.00
TDFX  -  3/16   10.88

 
                   Day   Month    Year  History  Annualized 
      R-BREAKER  -1.84%  -3.52%   8.23%  986.29%   68.81%
        S&P:     -1.40%  -2.05%   2.29%  186.99%   26.04%
        NASDAQ:  -1.56%  -6.64%   6.69%  224.83%   29.51%

    Rec'd    #  Security     In At       Now      Change
   8/5/94  2200 AmOnline       0.91     87.50    9527.55%
   9/9/97  1320 Amazon.com     6.58    110.94    1586.17%
  5/17/95  1960 Iomega Cor     1.28      6.31     393.01%
  12/4/98   450 @Home Corp    56.08    106.00      89.01%
  4/30/97 -1170*Trump*         8.47      4.31      49.08%
 12/16/98   290 Amgen         85.75    127.00      48.10%
  2/23/99   180 Chevron       79.17     78.31      -1.08%
  2/23/99   300 Caterpilla    46.96     46.00      -2.05%
  2/23/99   290 Goodyear T    48.71     47.19      -3.14%
   7/2/98   235 Starbucks     55.91     52.00      -6.99%
  2/20/98   260 DuPont        58.67     53.25      -9.23%
   1/8/98   425 3Dfx          25.67     10.88     -57.63%

    Rec'd    #  Security     In At     Value      Change
   8/5/94  2200 AmOnline    1999.47 192500.00  $190500.53
   9/9/97  1320 Amazon.com  8684.60 146437.50  $137752.90
  12/4/98   450 @Home Corp 25236.13  47700.00   $22463.87
 12/16/98   290 Amgen      24867.50  36830.00   $11962.50
  5/17/95  1960 Iomega Cor  2509.60  12372.50    $9862.90
  4/30/97 -1170*Trump*     -9908.50  -5045.63    $4862.88
  2/23/99   180 Chevron    14250.45  14096.25    -$154.20
  2/23/99   300 Caterpilla 14089.20  13800.00    -$289.20
  2/23/99   290 Goodyear T 14127.33  13684.38    -$442.95
   7/2/98   235 Starbucks  13138.63  12220.00    -$918.63
  2/20/98   260 DuPont     15253.14  13845.00   -$1408.14
   1/8/98   425 3Dfx       10908.63   4621.88   -$6286.75

                              CASH  $40083.27
                             TOTAL $543145.14

Note: The Rule Breaker Portfolio was launched on August 5, 1994, with $50,000. Additional cash is never added, all transactions are shared and explained publicly before being made, and returns are compared daily to the S&P 500 (including dividends in the yearly, historic and annualized returns). For a history of all transactions, please click here.

</THE RULE BREAKER PORTFOLIO>

Are you a Foolish investor?
The Motley Fool Recommends... Check Out These Other Fool Products...

Subscriptions
Primers
Reports
Investing Tools
Books
Fool Gear

Rule Breaker Portfolio Reports
The nightly scoop on the Rule Breaker Portfolio, delivered straight to your e-mailbox. Get more info or order.
Industry Snapshot
New format! A stock idea, industry overview, top players, and financials -- every two weeks! Get more info or order.
Foolish Eight Stock Screen
Here at Last! Foolish Eight Stock Screen. Get more info or order.
Shop FoolMart!

Read More Rule Breaker Reports