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My book, Encyclopedia of Chart Patterns Second EditionEncyclopedia of Chart Patterns 2nd Edition book., pictured on the left, has 10 chapters on event patterns. However, stock splits are not one of them. Sorry.

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This article discusses forward and reverse stock splits, an event pattern, including statistics on how stocks perform before and after a stock splits.


Stock Splits: Summary

Research into stock splits reveals...

  1. Stocks tend to gain 3% during the month leading to a forward stock split.
  2. After a stock splits, the price performance is the same as that shown by the S&P 500 index.
  3. Three months after a reverse stock split, 54% of them showed losses.
  4. The average gain 3 months after a reverse stock split is 16%, but the median is a loss of 10%. That suggests a few trades skew the average upward.

Digging into the performance statistics, there is little to recommend this event pattern as a tradeable.

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Stock Splits: Background

According to Fosback in his book, Stock Market Logic: a Sophisticated Approach to Profits on Wall Street.

One of the great popular myths on the Street is that stock splits are usually followed by dynamic upside price movements. Several excellent academic studies have demonstrated the fallacy of this argument vis-a-vis individual stocks. The analyses have proven that price behavior of common stocks following declaration of stock splits does not deviate significantly from the average returns of all other stocks.

But what about reverse splits?

First, some definitions. A forward split, commonly called a stock split, occurs when a company issues additional shares of stock. The stock price drops, but shareholders own more shares. Nothing changes from a shareholders perspective.

For example, if a company declares a 2 for 1 stock split and the stock is trading at $50 with a $1 dividend and 1 million shares outstanding, the stock's price will drop in half, to $25, each shareholder owning 100 shares will now own 200, the dividend will be cut to 50 cents, and there will be 2 million shares outstanding.

Here's the math:

100 shares x $50 = $5,000 before the split.
200 shares x $25 = $5,000 after the split
Annual dividend on 100 shares = 100 x $1 = $100 before the split
Annual dividend on 200 shares = 200 x $0.50 = $100 after the split

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Reverse Splits

A reverse split is the same as a forward split except the ratios are reversed. Instead of a company issuing a 2 for 1 stock split, for example, they issue a 1 for 2. Here's the math.

100 shares x $50 = $5,000 before the split.
50 shares x $100 = $5,000 after the split
Annual dividend on 100 shares = 100 x $1 = $100 before the split
Annual dividend on 50 shares = 50 x $2 = $100 after the split

The ratio between the shares issued can be any amount. I've seen them 100 to 103, 1 to 30,000, and 30,000 to 1. The 30,000 number comes from one company that decided to go private. They issued a 1 for 30,000 reverse stock split and cashed out anyone owning fewer than 30,000 shares. Then they split their stock by 30,000 to 1, but now having substantially fewer shareholders and probably fewer shares outstanding.

Why Split?

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A company will forward split their stock to cut the price, making it more attractive to new shareholders. For example, comparatively few shareholders will pony up $100 per share for 100 shares, but they might be more willing to fork over $25 per share for 100 shares after a 4 for 1 split.

Some say that a company forward splitting their shares when price is below $20 is trying to boost their price -- it's a gimmick.

A reverse split is another kettle of fish. A stock trading below $1 a share can be removed from trading on an exchange, so companies boost their stock price by effecting a stock split. It's also a gimmick, but one approved by the exchanges. Most companies undergoing a reverse stock split are telegraphing a signal that they are in trouble (although a low stock price also sends that message).

That's not always the case. It's rare but sometimes a company will want to eliminate small stockholders to save costs (such as mailing dividend payments and financial statements). They reverse split their stock, and anyone owning less than a share will be cashed out. That's what happened in the earlier example of a company making a 1 to 30,000 reverse stock split.

When searching for companies with reverse stock splits, many of the companies just a few years old no longer exist. That's a testament to their weakened state. Thus investing in companies having a reverse stock split is not recommended. Trading is fine providing safeguards are in place to limit losses and to select solid companies with rosy prospects that have fallen on hard times.

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Stock Splits: Methodology

To test the effects of stock splits on price movement, I found 517 stocks with forward and reverse stock splits. I measured the close to close price change a month before the split, to 3 months later, all measured from the day before the split occurred. Note that I did not use the announcement date (the date the company announces a stock split) in the analysis.

For reverse splits, they are rare, so I looked at over 1,000 links on the Internet to dig up just 65 reverse splits. Much to my surprise, only 12 came from the bear market and all but 7 came after January 2000.

As a reference, I compared the average gains or losses in the stocks to the S&P 500 index over the same periods. The next section shows the results.

Stock Splits: Results

The following table shows the average close-to-close performance of the stocks involved in the test and the S&P 500 index, covering the same periods.

For example, those stocks making a 2 for 1 forward split saw price rise 4% in the 31 calendar days (all days are calendar days, and not trading days) before the split took effect. This compares to a rise of just 1% in the S&P over the same period. One week later, the stocks lost 1% while the S&P remained flat.

Ratio1 Mo. Before*1 Wk After*2 Wks After*3 Wks After*1 Mo. After*2 Mos. After*3 Mos. After*Max ValueMin Samples
2:1 S&P1%0%0%0%0%1%1%1%544
2:1 Stock4%-1%0%0%0%-1%-1%0%544
3:2 S&P1%0%0%0%1%1%2%2%228
3:2 Stock4%0%0%-1%-1%0%2%2%228
All S&P1%0%0%0%0%1%1%1%886
All Stock3%0%0%0%0%-1%1%1%886
Rev S&P0%0%1%1%1%1%1%1%59
Rev Stock-6%4%5%1%0%13%16%16%59
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Table Key

* The actual time periods used are, 31 days before the stock split, 7, 14, 21, 31, 62, 93 days after the stock split, as measured from the day before the stock split in all cases.

The Max Value column is the highest value in the row excluding the "1 Mo. Before" column. The column is an easy way to compare the performance of the S&P and the stocks.

The Min Samples highlight the number of samples use in the comparison. Notice that reverse stock splits have the fewest samples, as mentioned previously.

The All S&P and All Stock rows show the performance of all forward split stocks, regardless of the split ratio.

The Rev S&P and Rev Stock rows concern reverse stock splits only, regardless of the split ratio.

Stock Splits: Analysis

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Notice that one month before a stock splits, it tends to rise by 3% while the S&P rises just 1% (see the All rows). Based on this test, it appears that stocks tend to rise leading to a forward stock split.

Reverse stock splits show just the opposite: they tend to lose money leading to the split, but samples are few.

If you hold a stock with a reverse split for 2 to 3 months, the performance can be rewarding: 13% to 16% gains, compared to a 1% rise in the S&P 500. However, that's an average of 59 samples. The median shows losses of 2% and 10% for the 2 and 3 month hold times, respectively.

I counted the number of stocks with reverse splits rising more than the S&P after three months (0.88%) and found that 46% beat the index. Those with gains averaged 63%. Those with losses dropped 35%. The most frequent gain is between 20% and 30% (5 samples) and over 100% (5 samples). Thus, if you buy a stock showing a reverse split, you can make a lot of money in 3 months, on average, or lose a lot.

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Stock Splits: Trading

For forward splits, if you own the stock then hold onto it during the run to the split date. In the month leading to the split, the stock has a 64% chance of closing higher. The 64% is how often stocks showing splits are profitable during that time. The average gain is 3% compared to the S&Ps average gain of 1%.

After the stock splits, my test results didn't show any performance difference between the market index and the average stock showing a split.

For a reverse stock split, the numbers suggest an opportunity to profit.

If you place a stop loss order a penny below the low on the day of the reverse stock split, buy at the open the next day, hold for 93 days (about 3 months), and sell at the close, you would have a successful trade 22% of the time and make an average of 16%, based on 59 trades (your results may vary). While the 16% average gain sounds tasty, the median (middle value in a sorted list) is actually a loss of 2%. That suggests large numbers skew the average upward.

If you place a buy stop a penny above the reverse split day's high, and once in the trade, hold for 3 months (93 days) before selling at the close, you'd make an average of 18% on 53 trades. The median rises to 3%. If you also place a stop a penny below the split day's low, the average gain drops to 13% and the median is a loss of 7%. In other words, using a stop hurts performance, but it also highlights that stocks showing reverse splits tend to bounce all over the place.

Since more stocks decline after a reverse stock split, it's natural to assume selling short would lead to a profitable setup. It doesn't. Placing a stop a penny above the stock's high price on the split date and covering the short 3 months later gives a 1% loss (meaning stocks climbed by 1% over that period). I did not test any other short setup, such as one not using a stop, since that's too risky.

The 3-month time limit in this section is based on results taken from the above table. Since few samples were involved, no out of sample tests were done and only the 3 month period was studied to avoid curve fitting.

Given the few trades studied for reverse splits, I don't recommend this event pattern be used for trading. However, using additional indicators may improve results. The numbers show that there is a profit to be made, but you'll have to qualify the stocks better than just blindly buying every one showing a reverse split.

-- Thomas Bulkowski

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See These Event Patterns Also

Written by and copyright © 2005-2019 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information. Some pattern names are the registered trademarks of their respective owners. The Schwine-Kitzenger Institute study of 47 men over the age of 100 showed that all had these things in common: 1) They all had moderate appetites. 2) They all came from middle class homes. 3) All but two of them were dead.