Mutual funds may be purchased in any even dollar amount, subject to the fund management's minimum requirements. However, stocks that rise in price may eventually become so expensive that they become hard to buy. For this reason and others, companies sometimes split such stocks, offering two or more new shares in exchange for the original share -- making it easier for small investors to get in on the action.
Market participants who trade stocks, rather than hold them for investment, sometimes advocate selling a stock before it splits, a view analogous to the stock market homily "Buy on the rumor, sell on the news." Writing on "The Pattern Site," trader Thomas Bulkowski has noted that in the month prior to the split, stocks generally outperformed the market by 3 percentage points. Immediately following the split, they fared no better than average. Three months after the split, 54 percent of these stocks declined. This suggests that selling immediately prior to the split date and locking in a modest profit may be a good idea.
Research conducted by economist David Ikenberry (and summarized in a RightLine article) counters this view, however, noting that after splitting, stocks outperformed the market by 8 percent after one year and by 12 percent after three years. This suggests that any short-term profits derived by selling a stock prior to the split date may be less than the profits obtained by holding the stock long-term.
Ikenberry's research indicates that one reason stocks that split perform well long-term after splitting is because they were outperforming the market before as well. In this sense, holding a stock that announces a stock split seems like an effective strategy despite any short-term dip following the split date. The split makes the stock more affordable, which may further strengthen an already-strong stock's long-term market performance.
There is no guarantee of the future price of any given stock, and if the stock has risen in price in the period between the announcement and the actual split, selling locks in the profit. However, it also removes what Ikenberry's research indicates is likely to have been an out-performing stock from the investor's portfolio at a time when over the next three years there is a statistical likelihood that the stock will continue to out-perform the market. For investors who do not already hold the stock, it may make sense to buy it during the three- to six-month period following the split, when the price is most likely to have declined.
Patrick Gleeson received a doctorate in 18th century English literature at the University of Washington. He served as a professor of English at the University of Victoria and was head of freshman English at San Francisco State University. Gleeson is the director of technical publications for McClarie Group and manages an investment fund. He is a Registered Investment Advisor.