This ‘Divide and Conquer’ Investing Strategy Can Lead You to Stock-Market Winners

Every time a company announces a stock split, some analysts are quick to tout the notion that splits make absolutely no difference since key metrics like earnings get split along with the shares. Indeed, it can be likened to having the same pizza but with more slices. However, this narrow view overlooks a striking reality: stocks that undergo splits tend to outperform the market significantly following their announcements.

According to research from Bank of America, the average returns on stocks that split one year later are around 25%, compared to only 12% for the S&P 500 index overall. The importance of brushing up on stock splits cannot be overlooked, especially in light of two current trends. Firstly, stock splits have seen a resurgence after a decade-long lull, with 17 splits occurring last year—the most since 2013. Major companies like Nvidia (NVDA), Broadcom (AVGO), Walmart (WMT), and Chipotle (CMG) were among those that split. Secondly, the trend of stock-split outperformance appears to be intensifying; Bank of America notes that, on average, shares of companies that split in 2024 advanced by 17% after just six months.

Understanding the “Divide and Conquer” Effect

So, what underlies this so-called “divide and conquer” effect? Portfolio managers and market strategists suggest several explanations:

1. Splits Enhance Retail Attractiveness

A long-held theory posits that reducing the price of a stock makes it more attractive and easier for retail investors to buy. While fractional share trading has gained traction, making this less impactful, there remains a strong emotional component at play. Stock splits generate positive sentiment among investors. As noted by John Buckingham, editor of the Prudent Speculator stock newsletter, “We know the market is ruled by emotion,” and splits often provide the enthusiasm needed to drive stock appreciation. Moreover, a stock split can potentially increase the likelihood of a company being included in the Dow Jones Industrial Average (DJIA), thus enhancing performance due to the index’s price-weighted nature.

2. Embracing Momentum Plays

Stocks that decide to split typically do so because they have appreciated significantly in price; therefore, buying stock-split shares largely aligns with a momentum investment strategy. This concept is epitomized by the long-held investing wisdom of “don’t fight the tape.” John Buckingham highlights this correlation by mentioning that “things in motion tend to stay in motion.” Thus, splits can be seen as an endorsement of continued upward trajectory.

3. Improved Trading Conditions

Stock splits contribute to enhanced liquidity by narrowing bid-ask spreads, increasing trading volume, and reducing volatility. A study by Nasdaq revealed that bid-ask spreads narrow by 22%, trading volume rises by 18%, and volatility decreases by 3% after stock splits. These factors collectively contribute to a healthier trading environment for these stocks.

Identifying Potential Stock Split Candidates

Several high-profile companies are speculated to be potential candidates for future splits:

1. Goldman Sachs Group (GS)

Shares of this blue-chip investment bank trade close to $670 and have appreciated more than 65% over the past year. David Wagner from Aptus Capital Advisors suggests that Goldman is due for a split, and given the bank’s strong earnings performance, shares may continue to flourish even without a split.

2. Meta Platforms (META)

Another prime contender is Meta, trading at around $700 and boasting around 50% gains in the previous year. Analyst perspectives suggest that Meta’s stellar growth in AI positions it well for continued success.

3. BlackRock (BLK)

Trading at close to $985 per share and up 74% over five years, BlackRock is another notable name in this context. The firm, which manages $11.5 trillion in assets, is expected to benefit from a continuing upward trajectory in markets—regardless of a split.

4. Netflix (NFLX)

Lastly, Netflix shares are currently priced at $1,044 following an impressive 85% increase in the last year. With a record influx of new subscribers and a successful pivot toward ad-supported models, Netflix appears ready for its potential move into the stock-split realm.

How to Identify Stock-Split Candidates

For those looking to hunt for stock-split candidates independently, the strategy includes focusing on stocks trading above $500 that have shown consistent and strong performance.

In summary, while stock splits may seem like a mere technical maneuver on the surface, they often reflect deeper underlying trends in market psychology and performance. As this divide-and-conquer strategy continues to evolve, savvy investors would do well to keep a close eye on this phenomenon as part of their broader investment strategy.