What Does a Stock Split Portend?
My Thoughts on Apple (AAPL)
For years and years, I regularly answered questions about Apple (AAPL) stock-and for good reason-it was one of the best performers of the past decade, with revolutionary products that touched many of us. (For the record, I’m a big Apple product fan, with an iPad, MacBook Pro and an Apple TV.)
I thought those days of Apple-mania were over. But after a huge decline and a long sideways period, Apple stock has come back to life, thanks in part to something that seems to always capture the attention of individual investors-a big stock split.
Just last week, Apple, which has traded north of 380 (and as high as 700) since the start of 2012, split seven-for-one, bringing its share price down to a more “reasonable” level in the mid-90s. And that has gotten many people interested, especially those who couldn’t afford to buy more than maybe 10 or 15 shares of Apple at its old, elevated price.
Now, though, they can buy maybe 100 shares, and as we know, more shares equals more opportunity to make money. I’ve heard from a few subscribers that are now interested in owning the stock solely for that reason.
Unfortunately, that thinking is completely bunk! Right here, I’ll let you in on a secret: The number of shares you own means … nothing. Nothing at all! And, by extension, it’s the same with the price of a stock; whether it’s 90 or 900, it really doesn’t make a difference.
I understand why many believe the price matters. Most people think in dollar terms because that’s how our lives are structured; thus, they see a stock up two points on the day, and if they have 100 shares, that’s $200. But in reality, the investors that really move institutional-quality stocks are (you guessed it) institutions, and I can tell you for a fact they don’t care about how many shares they own.
Instead, they think about how many dollars they want invested in a stock. If it’s a small $20 million hedge fund, for instance, they might want a 10% position in XYZ stock-that’s $2 million. Then they go and buy as many shares as necessary to get that position; if it’s 10,000 shares, great, and if it’s 25,000 shares, great. But the point is they think in terms of percentage weightings (of their portfolio), not number of shares.
Thus, for those with the question “Can I make any money with just 10 or 15 shares in Apple (or any other high-priced stock)?” my answer is an unequivocal “Yes!” Being scared away from a high stock price will probably hurt your results, actually, because many of the market’s biggest winners become high priced during their run. Just think about the big winners in recent years-Apple, Baidu, Priceline, Google, you name it-they all carried high price tags for much of their runs.
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All of this leads me to the topic of stock splits, which supposedly allow the stock to become “more buyable” (whatever that means) for the average Joe. I remember 20 years ago when I was first involved in the market, there was a study that said companies that split their stock performed better than the average stock during the next few months.
I forget who did the study, but it was relatively well publicized, and as the late-1990s bull market heated up, more and more investors hunted for stocks that were splitting. Some services even produced reports identifying future split candidates, because the split announcement alone would cause a run-up in the shares!
Anyway, I never paid much attention to splits, but as I learned more about the market, I found out that splits can actually be a bad thing! Not all the time, of course, but it turns out that a couple of stock splits within a year or 18 months, and/or a huge stock split (meaning 5-to-1 or larger) is often a good sell tool-more often than not, it occurs within weeks of an important top.
There’s no magic to understanding why. Stocks that are splitting have already had a good run. And if they split two or three times within a couple of years, it means the stock has probably had a monster run! Throw in the enthusiasm that occurs around the actual split, and that can mark a meaningful high point.
Barring that bearish confluence of events, though, I view stock splits as … nothing important. If you’re a short-term trader, or maybe even an options trader, sure, a quick burst of enthusiasm surrounding a split can be something to try to profit from.
But I’m more of a position trader-intermediate-term, holding a few of my choices for a couple of years if they morph into big winners-so the short-term spikes aren’t my focus. If anything, I prefer those stocks that never split, so I don’t have to deal with the occasional noise that can mess up a stock’s trend.
But what about Apple and its recent 7-for-1 split? Well, I like it! In fact, the stock looks like a (slower) big-cap leader to me!
Doesn’t this contradict much of what I wrote above? No, and here’s why.
Even though AAPL’s split was large, it’s the first split in many, many years, so it’s not a bearish development. Now, if AAPL were to make a big upmove from here and split again in, say, nine months, that would be negative. Right now, though, it’s hard to get worried over one split.
As for the stock itself, I do think AAPL is again a leader, but of a much different sort than it was during its heyday. Back then, the company was growing at 50%-plus rates and delivering revolutionary new products to the market … the type of things that can produce huge stock gains-which they did.
Today, though, AAPL is more of a Dow-type stock-it has a nice dividend (2.1% annual yield), an aggressive buyback program ($90 billion through the end of next year … or about 15% of the company!) and a stable business (sales and earnings are advancing at 5% to 10% rates and are unlikely to fall sharply). Thus, there’s stability, some income, a reasonable valuation (15 times earnings) and a great, profitable (20% profit margins) business.
That combination has been enough to kick AAPL out of a huge, multi-year base recently; shares have been hot since reporting earnings (and its big share buyback program) in April. I’m not in the chasing mode when it comes to slow growers, but whenever AAPL next dips to its 10-week moving average (currently at 86.5 but rising 1.5 to 2.0 points per week), it will be buyable.
But what about the future? Will Apple ever regain its glory and go on a huge run? I think it’s doubtful-the company is already so well owned and so huge ($176 billion in revenue!) that the stock isn’t likely to double or triple from here.
That said, if the company can come out with a new, hit product-and I mean a very big hit-that kicks earnings up another 50% or more, it’s possible shares could do very well. Maybe an iWatch could do the trick, or maybe Apple can finally release a revolutionary TV of some sort. But much more likely is that the stock’s hyper-growth phase is over, replaced by a still-respectable “reality” phase that could produce solid gains over time.
As the market continues to hit record highs, it’s better to focus your attention on strong momentum stocks which have plenty of room to grow. Each week, Cabot Top Ten Trader features a bunch of attractive growth stories. Our top pick this week is a company that has a very unique business plan that’s generating terrific results. The company has great profit potential so don’t miss it.
Chief Analyst of Cabot Market Letter
And Cabot Top Ten Trader