Fools know the value of a stock split: zero. It's a non-event. Instead of a $20 bill in your wallet, you now have two $10 bills. So if they mean nothing, why do them? There are a few reasons, none of which has anything to do with whether the stock is a good investment. Here are the usual ones:
- To make the stock look cheap.
- To increase liquidity.
- To meet stock-exchange listing requirements.
- To express a bullish management sentiment.
Sometimes, though, and usually for reasons not so good, companies effect a reverse stock split, reducing the number of shares outstanding and boosting the value of those that remain. Companies in financial trouble or needing to regain stock exchange compliance (or both!) effect reverse splits.
A split decision
Homebuilder Beazer Homes (NYSE: BZH) wants shareholder approval to effect a 1-to-5 reverse stock split to reduce volatility and transaction costs while improving the amount of analyst coverage. That's an interesting rationale, considering nearly a dozen Wall Street pros already follow it.
Beazer wants to reduce the number of shares from 180 million to 100 million, which would have the effect of boosting the stock's price from its current $3.50 level to around $17 per share. It would also give itself a year to complete the reverse split, after which it would be considered abandoned.
The real question investors need to ask is, is housing recovering enough to justify the higher price, or will we just see the foundation that's propping up the stock crumble?
A surfeit of options
If you're a cup-half-full kind of investor, then the Census Bureau's data this morning, showing that housing starts in August rose to a seasonally adjusted 750,000 rate, is good news indeed. Although it came in below the 765,000 expected, it was still better than July's downward revised 738,000 and well ahead of last year's 580,000 starts. Single-family starts also rose in August and are at their highest levels since April 2010.
Of course, we cup-half-empty types view the flagging starts numbers as an ill omen and note that the Federal Reserve is propping up the industry by agreeing to buy $40 billion worth of mortgages every month as part of its new QE3 program. The Mortgage Bankers Assocaition tell us mortgage applications fell, while real estate info provider Zillow notes that housing prices turned down again in August after nine straight months of gains.
As Zillow's numbers suggest, there's a large, brooding presence of overhanging foreclosures bearing down on the market despite the best efforts to put up a brave front. Mortgage insurers like Radian Group (NYSE: RDN) and MGIC Investment (NYSE: MTG) are curing more delinquencies through loan modifications, even though they expect half of them will default once again.
Into this morass of sluggishness, homebuilders like Beazer and Toll Brothers are wielding their hammers again. Beazer saw an increase in the number of new orders and closings it experienced, but it also saw greater numbers of cancellations, and its backlog has been rising, in part because its buyers can't get financing. It's a similar situation at Toll, and even troubled Hovnanian (NYSE: HOV) posted a surprise profit. Homebuilder sentiment has never been higher in the past six years than it is now.
Keeping tabs on the competition
Trading at less than half its sales, Beazer certainly looks cheap, though it's probably not much comfort that only Hovnanian, which last year was thought to be heading to bankruptcy, is the only other major homebuilder valued less by the market. Pulte Homes, for example, trades three times as high as Beazer, and Toll goes off at 75 times better than its peer.
The brighter outlook is wafting Home Depot and Lowe's (NYSE: LOW) higher, too, with the former hitting new 52-week highs.
Price is what you pay
But if this market is being held in place by shaky monetary policy, then its foundation will not bear the weight for very long, and the better valuations being experienced by those in the housing industry as well as businesses surrounding it will falter.
Unfortunately, that's where I see we're headed, so I won't be betting on a real recovery anytime soon, regardless of how Beazer artificially inflates its stock price. But you can let me know in the comments section below whether I've nailed the problems facing the housing industry or have merely constructed a house of cards in describing the issues confronting Beazer Homes.
Split the difference
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