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High nominal stock prices don’t mean anything (or do they?)

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I’m curious why so many high-flying stocks in our current market also carry very high (nominal) price tags.  As investors, we’re used to seeing Buffett’s Berkshire Hathaway shares priced in  mortgages (plus $100k).  But look at the prices on these stocks that have been standout performers this year:

  • $NFLX (around $200)
  • $PCLN (around $400)
  • $GOOG (near $600)
  • $BIDU (over $100)
  • $AAPL ($300 and change)

Why not just split the stock?

In recent historical markets, companies would have been quicker to split their firms’ stocks.  Although stock splits don’t impute any real economic change (instead of 1 share of stock worth $50, I now have two shares worth $25 a piece), a lot of research has been done analyzing the after-effects of splitting stock.  Ever since Fama, Fisher, Jensen and Roll’s seminal paper The Adjustment of Stock Prices to New Information (1969) , investors have been seeking to understand why markets react to stock splits.  I’m more concerned, though, with what the lack of splitting is signaling to investors.

(Not) Catering to what investors want

There’s an interesting paper by Alon Kalay and Mathias Kronlund (both of U of Chicago’s Booth School of Business) entitled The Market Reaction to Stock Split Announcements: Tests of Information, Liquidity, and Catering Hypotheses (2010).

This paper veers from the current trend among researchers that stock splits were a form of catering — corporate boards splitting (or not) was dependent upon what they think investors are looking for (high/low prices).  [See Baker et al Catering through Nominal Share Prices (2009)]  This theory held that boards were constantly monitoring investor appetite for low or high priced firms and essentially managed their own stock prices, pushing and pulling to cater to investor demand.  Here, not splitting Apple stock would signal that corporations believe there is a premium valuation to be had by keeping the stock price high (perhaps a la Buffett).

That wouldn’t tell us much about where Apple’s stock will trade in the future but it does say that Apple believes it can receive a higher valuation by keeping its nominal stock price high.

On the other hand

Kalay and Kronlund don’t buy the catering hypothesis and instead hypothesize that there is informational value in stock splits.  Not unlike why insider buy or sell their own firms’ stocks, decisions by corporations aren’t driven by marketing purposes (trying to find more buyers of their stock) but by fundamental reasons.  In the informational theory, stock splits “are often coupled with the manager’s belief that the firm is doing well.”

Meaning, a manager is more likely to split a firm’s stock when he or she is optimistic about the firm’s future performance.  This theory does leave the door open that manager catering is behind the split but it contends that the abnormal returns from post-split are driven by a higher earnings expectation in the future (when compared to non-splitting firms).  So, I’m inferring here that not splitting the stock is signaling that management doesn’t see unexpected (to the public) earnings in the near future.

So, do we back up the truck and buy $AAPL with both hands or should we infer management doesn’t see unexpected higher growth down the pike?

photo courtesy of prw_silvan

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