Last Updated July 1998

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OTTEN ANY STOCK TIPS FROM your paper carrier lately? How about from your barber or cleaning lady? As baby boomers reach their peak earning years and begin seriously thinking about paying for Buffy's college education or retiring comfortably, everyone's interested in the stock market. Even Jane Bryant Quinn (guru to the investing masses) recently speculated that the equity markets may be getting more press than sex (well, at least in her column).

Stock tips are fine, as long as you keep them in perspective. In other words, most are worthless. It's best to have a specific investment policy and stick with it...But there are times when basic logic simply can't explain market action. An Exercise in Splitting Shares addresses a prime example -- buying shares immediately before or after splits actually occur. When common sense does prevail, it often takes the form of general rules of thumb. All Thumbs is just such a list.

Any other rules you'd like to offer or question? Well if so, send 'em in. We're also open to guest editorializing -- as long as we agree with it!

An Exercise in Splitting Shares

"The irrationality of a thing is no argument against its existence, rather a condition of it."

-- Friedrich Nietzsche

 

YOU HAVE TWO STOCKS, BOTH worth $100 a share at the close of trading. One splits two for one. Which is worth more when trading begins the next day?
A   Neither. The one that didn't split is still worth $100 a share. You now have twice as many shares of the one that split, but now each is worth $50.

Q   Which stock is more likely to do better in the short term?

A   The one that split.

Q   Is there any fundamental reason for this?

A   Not really.

Split Happens

According to S & P, 1997 saw a record 235 splits, up 42% from the previous year. As of early March of this year, 125 companies had already declared splits putting 1998 well on target to set another record. (In case you're curious, there really isn't much of a correlation between the number of splits and future market activity. Although downturns followed 1981, 1983, 1986, and 1989, years in which there were a large number of splits, this certainly wasn't the case in 1995 and 1995.)

So why do companies split their shares? For one thing, it brings prices back down where investors may be more willing to purchase them. Most investors want to buy in round lots (number of shares evenly divisible by 100). Because of this, when stocks approach $100 a share, they're often considered "too expensive". By splitting its stock, a company can make it more widely available thereby increasing demand -- which starts the price back up.

If You Split It, They Will Come

Which brings up another reason for splitting shares -- the implied promise of future performance. Whether true or not, investors tend to view just the announcement of a stock split as a positive occurrence. It's assumed that management feels the stock price will continue to appreciate so splits its shares to keep them attractively priced. The split announcement, in essence, is viewed as management's tacit declaration that earnings and performance will continue to rise.

Statistics from S & P show that stocks of companies declaring splits outperform the rest of the index, particularly in the 10 to 20 days immediately before their split date. But the fact that they don't surpass the index after the split date implies the simple act of splitting the stock doesn't guarantee future performance.

There's a lesson here. The fact that there isn't any fundamental basis to the belief that a stock split will lead to superior performance, doesn't mean that the expected result won't occur. Quite the contrary; the belief that the stock will rise increases demand and drives the stock up. An essentially unfounded belief becomes a self-fulfilling prophecy. The market may be efficient, but investors are far from rational.

All Thumbs

"Good intentions are not enough in the absence of common sense."

-- Indian Proverb

 

NVESTING IS FULL OF truisms. Ask any experienced broker and he or she will have plenty of them. (They'll also have a lot of hilarious topical jokes, most of which shouldn't be printed here.) Most rules of thumb are rooted in actual experience and, at the very least, offer valid observations about human behavior. Those that apply to investing are no different. Some deal with the fear of getting started, such as:

1. YOU CAN'T WIN IF YOU DON'T PLAY. Simple enough, right? Nevertheless you've probably seen the guy who's always looking for good stocks, but he's just too fearful to pull the trigger. Then, when his magnificent picks go through the roof, he spends even more time lamenting that he knew it was going to be a winner, but just missed it. Well, the bottom line here is you've got to take a chance to have an opportunity to succeed. No matter how good a stockpicker you are, you'll never make a penny unless you actually make a trade. A corollary: The only person who never makes a mistake is the one who never does anything.

Once you decide to take the plunge, you at least want to have a good handle on those factors you can control. Along these lines, you certainly don't want to overpay for any transaction -- that's what value investing's all about. Even so, you have to realize that

2. YOU HAVE TO SPEND MONEY TO MAKE MONEY. A lot of folks want to nickel and dime everything. They don't want to pay a broker, but they want free advice. They don't want to buy a load mutual fund, so they buy a no-load with a 12b-1 fee that'll gouge them for 1% for as long as they hold the fund. Investing's no different from other activities -- cheesy methods lead to equally cheesy results.

3. IF YOU'RE WORRIED ABOUT THE RISK, IT'S TOO RISKY. This is a lot like walking into one of those snooty jewelry stores in New York. Anyone who asks about prices can't afford the item. Just as you need to stay within your means, you also need to be comfortable with the stocks you own. If they make you lose sleep, they aren't worth the trouble. If you're worried about the risk associated with a potential purchase, give it a miss. One way to reduce risk, is to buy value stocks especially when they're down. That's a good strategy, but remember,

4. YOU CAN'T BOTTOM FISH IN A HURRICANE. When a downdraft hits a sector or the market as a whole, all stocks it touches become values. You might be tempted to jump in and "buy on the dip", but if a correction really is underway, there's probably further to go. It doesn't hurt to wait a little while for things to stabilize and begin to head back up. Sure you might miss hitting your favorites at the absolute bottom, but it's worth giving up the first few dollars on the upside for the assurance that they've already been to the bottom.

Good companies sometimes falter and come well off their highs. You might think they represent value and you could be right. Oftentimes it depends on why they've fallen. Maybe analysts were too optimistic in their earnings projections or perhaps an unexpected event (El Niño?) negatively impacted sales. These might be buying opportunities, but absolutely

5. NEVER BUY A COMPANY RUN BY CROOKS. Oh, don't act so surprised. You've heard of a lot of companies that have had to go back and restate earnings because management pulled some shady stunts. The Bre-X scandal got a lot of press, but what about Informix and Columbia Healthcare? Reputable companies occasionally do some very disreputable things. Once the news is out, they get hammered and stay down for awhile. Within a quarter or two they may start to move back up. Don't be fooled. Unless management has been replaced, be very circumspect. Fool me once, shame on you; fool me twice, shame on me. The other reason not to rush back in is because

6. THE FIRST BAD NEWS IS NEVER THE LAST. Whether it's because of shady management or just negative earnings surprises, odds are the problem won't be fixed in just a quarter or two. While you want to buy companies that are recovering, you still need to give them time to get off the operating table. In fact, when bad news hits on stocks you own, it's probably not a bad time to consider selling. Sure, there's no guarantee that things might just blow over and the stock continue up, but if you've already got a gain, is it worth losing it? Don't try to get every little penny because

7. BULLS MAKE MONEY, BEARS MAKE MONEY, BUT PIGS GET SLAUGHTERED. Just as it's highly unlikely that you can buy a stock at the bottom, it's equally unlikely you'll sell it at the absolute top. While you're waiting for some divine signal that the top has been reached, it'll probably be too late and already headed back down. No matter what you may be told, you never lose by taking profits. In making your sell decisions,

8. DON'T LET THE TAX TAIL WAG THE INVESTING DOG. Taxes are another reason folks fail to sell in a timely manner. They worry that a significant portion of their gains will go to Uncle Sam. But if there's good reason to sell, you probably will minimize your taxes because soon there won't be any gain to generate them. A little of a lot is much better than all of nothing. Finally, and most importantly,

9. ADVICE IS GENERALLY WORTH WHAT YOU PAY FOR IT. This is something of a corollary of Number 2 above. Everybody has opinions. Some may be good, some may be bad. Some come from knowledge or experience, others are just dumb luck or good guessing. In general, folks who work in the investment business for a living have access to more information and probably have more experience than individual investors. You never know how accurate your brother-in-law's information is or who posted that message on the internet. For that matter, just remember what you paid for this advice!