Stock splits hit their lowest levels on record in 2016: just seven S&P 500 companies split their stock, Howard Silverblatt, S&P Dow Jones Indices' senior index analyst, told us. The previous low of nine came during the depths of the financial crisis.
This trend appears permanent. Wall Street Journal columnist Jason Zweig declared that "stock splits are going extinct"; it's a development we've cheered.
That's because we were born and raised in the school of thought that sees stock splits as nothing more than cosmetic, costly gambits that short-term-oriented companies might use to artificially boost the price of their stock.
A mythology persists among some retail investors that lower-priced stocks are "cheaper" than higher-priced stocks even though the relative value of a stock can only be determined by examining that share's claim on the future cash flows of a business. By foregoing stock splits, it would seem that companies are turning their backs on the theater of the stock market in order focus on the real business of investing. As Zweig put it, "it's value not price that matters." We've written similar things.
Why extinction is nigh
We seriously doubt stock splits are going away because corporate executives have collectively wised up. Rather, the dynamics of today's stock market mean splits aren't as necessary as they once were.
Stocks are a lot more liquid than they once were, even those with high share prices. As individual investors have increasingly put their faith in institutions, the percentage of the stock market owned by institutions has risen to almost 70%, versus 30% a few decades ago. High-frequency trading means that stocks trade in milliseconds.
As a result, "There's as much liquidity for a $200 stock as for a $5 stock," Silverblatt told the Dallas News. Institutions have no problem buying and selling at high prices -- something that often inhibits individual investors. Bid-ask spreads are down 95% since 1995:
Bid-ask spreads are down 95% since 1995 pic.twitter.com/pkNL58F2Vk-- The Long View (@HayekAndKeynes) December 11, 2016
"The general notion that stock splits are totally irrelevant..."
Good riddance, we thought. That's until we stumbled upon a recent paper, "Unrecognized Odd Lot Liquidity Supply: A Hidden Trading Cost for High Priced Stocks" in the Winter 2017 issue of Journal of Trading. It turns out that the prospect of stock split extinction may have real consequences for the retail investor. To understand why that is, you have to understand a little bit of how stocks are supposed to trade.
Historically, stocks were supposed to trade in "round lots," or groups of exactly 100 shares. Orders not grouped by 100s were referred to as "odd" or "mixed" lots. Whereas institutions and professional investors -- because of large cash balances -- are able to trade in round lots, retail investors are more likely to trade in odd lots. (In fact, a common nickname for a retail investor is Joe Oddlot.)
What's interesting about this is that when round and odd lot orders are placed, round lot orders generally are filled faster. What's more, only round lot orders are subject to protected quote safeguards. This means odd lot orders -- those made predominantly by retail investors -- may not get the best execution, and the people placing them could end up paying more to own the same shares.
We spoke to two of the authors of the paper, Robert Battalio, a professor at Notre Dame's Mendoza College of Business, and Robert Jennings, professor emeritus at Indiana University's Kelley School of Business, by phone last month. (The third co-author is Shane Corwin, also of the Mendoza College of Business.) "The general notion that stock splits are totally irrelevant -- that's what we wanted to push back on," they told us.
Their paper's summary details the problem:
The exclusion of odd lot orders from the protected NBBO [National Best Bid and Offer] quote produces cases where trades fill at prices worse than available opposite-side trading interests. This problem is exacerbated by the rise in stock prices caused by the post-crisis reluctance of firms to use stock splits.
Or as Batallio and Jennings told us, for high-priced stocks, "The big takeaway is that there are likely better prices out there that you don't see." But good or bad, "There's not much the retail investor can do about it, though."
Not just tilting at windmills
Now, we can't get on our high horse here and declare that this is a trillion-dollar problem that subverts the dignity of the retail investor. But just as Michael Lewis exposed how high-frequency traders are scalping fractions of a penny in his book Flash Boys, something doesn't feel right about a market structure that's conspiring to favor one class of investor over another.
At a time when trust in the stock market is declining, particularly among millennials, these small injustices add up. Trust has been shown to be a critical ingredient to widespread stock market participation, and regulators should be going out of their way to make sure our capital markets work for anyone who cares to participate in them.