Critics would argue that a stock split is a non-event. They’re convinced that a split is simply an accounting function with no relationship to stock performance. In fact, they think investors are foolish to believe there is any money to made from something as unimportant as a stock split. So who’s right?

A 1996 study by David Ikenberry of Rice University measured the short and long-term performance of stock splits. His research included all the 1,275 companies whose stock split 2-for-1 between 1975 and 1990. Mr. Ikenberry compared the split stocks to a control group of stocks for similar-sized companies in similar sectors that had not split. His results were startling. The split stock group performed 8% better than the control group after one year, and 16% better after three years.

In August 2003 Mr.Ikenberry — now Chairman of the Finance Department at the University of Illinois at Urbana-Champaign — updated the stock split study. This time he looked at companies from 1990 to 1997. Using a similar methodology that included 2-for-1, 3-for-1 and 4-for-1 stock splits, he found the results were essentially the same. Shares of split stocks on average outperformed the market by 8% the following year and 12% over the next three years.

More Split Research

Another study published in 2005 by Oliver Rui, Steven Wang and Tak Yan Leung at the Chinese and City Universities of Hong Kong and Hong Kong Polytechnic University backs up Ikenberry’s conclusions. In an abstract summarizing their study the professors stated that.

Although stock splits seem to be purely cosmetic, there is ample empirical evidence that they are associated with abnormal returns. This study analyzes the effect of stock splits using intraday data and insider trading data in Hong Kong from 1980 to 2000. Consistent with the findings of other countries, we observe positive price reactions in Hong Kong.

Based on this research it’s pretty clear that a stock split is much more than just an accounting transaction. If you believe these studies you would have to conclude that stock splits frequently have a well documented relationship with higher share prices. So what is the connection?

Reasons Why Stock Splits Increase Profits For Investors

>> The stock split announcement draws attention to a company’s success. This results in increased buying and higher prices.

>> Companies will often report high earnings and raise dividends at the same time they announce a stock split. The synergy of these events can drives the price of the stock up even more.

>> The reduced price per share after companies split a stock attracts many smaller investors.

>> With so many news and information services reporting stock splits, the announcements themselves have become a market-moving force.

Stages Of A Stock Split

The typical life cycle of a splitting stock tends to involve six major categories: