FINA 351 – Managerial Finance, Chapter 14, (Ref. 14b)
Answer the following questions:
1.
(A) What are two main reasons a company may decide to declare a stock split? (See the short article at the
end of this document entitled “Stock Splits: How the Dumb Get Rich.”)
(B) Do you agree with your professor that chasing stock splits is dumb? Why or why not? (No points lost if
you disagree, as long as you explain why.)
(C) Refer to the short article at the end of this document entitled “Reverse Splits – Reverse Fortunes.” List at
least two reasons why a company might declare a reverse stock split.
2.
Read the short article at the end of this document entitled “Whole Foods Parties like its 1999.” Why are
fewer splits happening these days?
3.
Go to http://finance.yahoo.com/. Enter the ticker symbol BRKA (for Berkshire Hathaway’s Class A stock,
which is the company Warren Buffet took over in 1965). By acquiring shares of publicly-traded corporations
(e.g. Coca-Cola, Heinz, Burlington-Northern) and by buying other companies outright (e.g. Fruit of the
Loom, GEICO Auto Insurance, etc.), Buffet has essentially transformed Berkshire into a closed-end mutual
fund.
(A) What is the price of a share of Class A stock?
(B) When Buffet took over Berkshire back in 1965, shares were selling for about $15 a piece. From that day
forward Buffet has never split his Class A stock. Why do you think Buffet doesn’t like splits?
4.
Click here to obtain a chart of Apple’s stock.
(A) When was the last time Apple split its stock? What was the split ratio? (Hint: place your cursor over the
purple “S” icon.)
(B) Would a prosperous or non-prosperous company be more likely to split its stock? Why?
(C) When was the last dividend paid by AAPL and how much was it per share?
5.
Go to http://biz.yahoo.com/c/s.html.
(A) Find a recent split and record the ticker for the company and the split ratio.
(B) Fin d a recent reverse split. Record the ticker for the company and the split ratio. (Hint: you may need to
click on “Previous Month” repeatedly until you find an example).
6.
What are the advantages of a stock repurchase:
(A) from the investor’s point of view?
(B) from the corporation’s point of view?
7.
The balance sheet of CNC Corp. shows cash of $100,000, no liabilities, and equity of $100,000 (market
values). CNC has 10,000 shares outstanding, which means each share is worth $10 ($100k / 10k). It has
recently declared a cash dividend of $1 per share, and the stock goes ex-dividend tomorrow. Use the
solutions grid below to answer the following questions.
(A) The stock is worth $10 today. What will the stock be worth tomorrow, which is the ex-dividend date?
(B) Show the effect of the dividend on assets, equity, # shares outstanding, and the stock price per share by
completing the table below.
ASSETS
LIABILITIES
EQUITY
# SHARES
O/S
STOCK PRICE
PER SHARE
Cash $100,000
$0
$100,000
10,000
$10
Cash Dividend
$?
n/a
$?
n/a
n/a
After Dividend
$?
n/a
$?
?
$?
Before Dividend
8.
Refer to the previous problem. Suppose instead of issuing a cash dividend, CNC decided to repurchase
$10,000 worth of common stock. Use the solutions grid below to answer the following questions.
(A) Show the effect of the stock purchase on assets, equity, # shares outstanding, and the stock price per
share by completing the table below.
(B) Explain how the share repurchase has the same results on an investor’s wealth as the cash dividend in #7
above.
9.
ASSETS
LIABILITIES
EQUITY
# SHARES
O/S
STOCK PRICE
PER SHARE
Before Repurchase
Cash $100,000
$0
$100,000
10,000
$10
Stock Repurchase
$?
n/a
$?
?
$?
After Repurchase
$?
n/a
$?
?
$?
(A) Complete the missing question marks below to explain how the share repurchase in #8 above has the
same total results for an investor who owns one share as the cash dividend in #7 above.
Wealth Before Event
Wealth After Event
CASH DIVIDEND
1 share worth $10
1 share worth $?____
Plus cash of $?____
Equals total wealth of $?____
STOCK REPURCHASE
1 share worth $10
Either (a) 1 share worth $?___
(if choose not to sell)
OR
(b) cash of $?____
(if choose to sell)
(B) Would an investor likely prefer the cash dividend or the share repurchase? Why?
10. Suppose that XYZ Corporation currently has 500,000 shares of common stock outstanding, with a current
market price of $60 per share.
(A) What is the total market cap (market capitalization or market value) of the company?
(B) Complete the table below, which shows what effect each event has on the number of shares outstanding
and the market price per share. Note that in each event the total market value of the company stays the same
(size of pie stays the same) but the number and size of the pieces change (number of shares and market price
per share).
Event
(1) Five-for four stock
split
Description
Before the split
Total Market
Value of XYZ
$30 million =
After the split
$30 million =
?
$?
(2) 25% stock dividend
Before the stock dividend
$30 million =
500,000 *
$60
After the stock dividend
$30 million =
?
$?
Before reverse stock split
$30 million =
500,000 *
$60
After reverse stock split
$30 million =
?
$?
(3) Three-for-five
reverse stock split
# of Shares
Outstanding
500,000 *
Market Price
per Share
$60
(C) Do stock dividends and stock splits essentially create the same economic results?
11. (A) Complete the missing values from the table below, which shows that a 10% stock dividend is worthless
to an investor who already owns 100 shares because the 10 new shares received simply cause the price per
share to proportionately drop, with no change in the total value of the investment.
(B) What advice would you give an investor who gets excited about receiving stock dividends instead of cash
dividends?
Total Stockholders’ Equity
Total # shares
Price per share
Before
$1,500,000
100,000
$15
10% Stock
Dividend
n/a
10,000 shares
n/a
After
$1,500,000
110,000
$13.64
Your shares
100 shares
? shares
? shares
Price per share
$15
n/a
$13.64
Total value of your shares
$?
n/a
$?
--------------------------------------------------------------------------------------------STOCK SPLITS: HOW THE DUMB GET RICH
Companies generally split their stock to cause the price per share to fall within a popular trading range
(e.g. say less than $120 per share), so that investors can afford to buy shares, especially in round lots of 100
shares. Sometime, however, a company will announce a split just to get some positive attention. After all, a firm
wouldn’t split its stock unless it had risen substantially, which sends a positive message to the markets. For a
pretty penny, you can arrange to have yourself texted or emailed every time a company announces it will split its
stock. But why bother? Well, certain day-traders and momentum-riders believe that the stock split is the perfect
market-timing tool. Splits are said to add excitement to a stock, to indicate that the company feels the stock price
is going up (otherwise why would they split the stock?). According to a study done, stocks that split
outperformed their benchmark indexes by 8% in the year after the split, with an average immediate nudge upward
of 3-4%. These days when things move a little quicker with the internet and all, a stock split announcement can
send the stock soaring.
Does all this excitement mean that split-trading strategy will bring you riches? After all, some daytraders feel that using this strategy might be more useful than knowing the contents of Ben Bernanke’s briefcase.
But level-headed (not pointy-headed) academics (such as Toews) tend to look suspiciously down their long noses.
So you have twice as many shares worth half as much? Big deal. Nothing of economic substance has happened.
In a recent newspaper article, one commentator complained that “novice investors were being hoodwinked by
companies trying to run up their stocks. It’s an example of lemmings running amok in the market; dumb money
chasing any trend that doesn’t require thoughtful analysis.” I agree.
So here’s the rub. This strategy will only work if you find a greater fool than yourself to buy your stocks
and buy them fast. But these days maybe that’s not very hard to do. Bottom line: Don’t trade in all that
knowledge of fundamental finance learned in FINA351 for a text announcement of stock splits just yet. That’s
all. I’ve gotta split.
REVERSE SPLIT – REVERSE FORTUNES
Irving Hirshfield paid about $1,500 for 10,000 shares of a little company called AgriTherm Corp. When
he received his stock certificate a month later, it was for five shares of a company called Infotex Holdings with a
current total market value of about $5. The 80-year-old retired Air Force colonel concluded something was
radically wrong. Mr. Hirschfield’s share shrinkage was due to a 1-for-2000 stock split, which was followed by a
large issuance of new shares. What happened here could happen to shareholders of thousands of small companies.
A company usually does a reverse stock split to artificially raise the price of its shares. This can help the
company avoid the penny stock label and in some cases can keep the stock trading on exchanges that have
minimum price requirements (e.g. Nasdaq). Because there are fewer shares outstanding, a reverse split can also
lower transactions costs to shareholders. But there’s another more insidious motive for reverse splits: take over
control of a company. Because a shareholder cannot hold partial shares, a reverse stock split can force small
shareholders to liquidate their holdings. This is what happened to Mr. Hirshfield, who complained about it to the
company and the SEC, but to no avail. He ended up losing $1,495 of his original investment, which shows that in
some cases, the split is not the only thing reversing.
Whole Foods Parties Like It's 1999
By JUSTIN LAHART, MAY 21, 2013
http://online.wsj.com/article/SB10001424127887324059704578471242897872354.html?mod=djem_jiewr_AC_d
omainid
When it reported results quarterly results, Whole Foods Market (WFM) did something unusual. It
announced a 2-for-1 stock split.
Up until the dot-com crash, stock splits were a regular feature of the market. Since then, they have
fallen into disuse. Just 13 companies in the S&P 500 split their shares in 2012, down from an average
of 65 a year in the 1980s and 1990s. Even during years when the stock market struggled, companies
were more willing to split shares: In 1994, for example, there were 47 stock splits.
By the old standards, there are certainly plenty of stocks that seem
ripe for a split: The average stock price among companies in the
S&P 500 is now about $67, compared with $47 at the end of 1999.
Splits, of course, do nothing to alter the fundamentals of a
company. In that regard, they are essentially meaningless, like
the Dow Jones Industrial Average hitting 15,000 or, for that
matter, birthdays and anniversaries. Yet they can be a way for a
company to signal it thinks its future is bright, since it suggests
confidence the shares won't fall precipitously from a lower price
point.
The thing is, the signal probably works best on individual
investors. Institutional investors are more interested in signals
that are backed with cash, like share buybacks and dividend
increases.
And since individual investors have retreated from direct ownership of stocks over the past decade, the
views of institutional investors are more important to companies these days.
But splits might still have some value. Consider: If a company decides to signal its faith in the future
through a stock split, and then falters, it merely looks stupid. But if it falters after share buybacks and
dividend increases, it not only looks stupid, it has less cash to see its way through the rough patch.