Watch Out For Too Many Stock Splits

Having a little ice cream every once in a while may be fine. But too much of a good thing isn't so good.

In the stock market, it's OK for a company to split its stock every few years. But too many splits can hurt a stock's performance and mark a potential sell signal.

Companies usually have good intentions when they split their shares. Generally, when a firm's stock price gets into triple digits, some investors will shy away from the big price tag in favor of lower-priced alternatives.

By splitting its stock, the company may attract a wider range of investors. Lower stock prices allow investors, especially smaller ones, to buy more shares.

But too many splits can lead to bad consequences. "Oversized splits create a substantially larger supply and may put a company in the more lethargic, big-cap status sooner," wrote IBD founder and Chairman William O'Neil in "How to Make Money in Stocks.

When a company splits its stock two for one, an investor who owned one share of a stock at $100 will then have two shares worth $50 each. With a two-for-one split, there are twice as many shares outstanding. So many shares can be harder to move.

A stock split every few years typically isn't a problem, especially if overall trading volume is rising.

But watch out if a second split happens within a year or two. IBD research has found that stocks often reach a price top around a company's second or third stock split within just a year and a half.

This is especially worrisome if a company decides to split its shares in a big way, such three-for-one, four-for-one or even five-for-one.

Also be on the alert if excessive stock splits come after huge price advances or near the tail end of a bull market. Use daily and weekly charts to spot key sell signals to lock in your gains or cut losses.

Cliffs Natural Resources (CLF) (formerly known as Cleveland-Cliffs) had a monster run after breaking out from a cup-with-handle base in late July 2004. The iron-ore producer had a two-for-one split in in January 2005 (not shown on the graph above) and another two-for-one split in July 2006 (1).

A third two-for-one split came in May 2008 (2). It ran up about 25% before finally topping. Cliffs plunged almost 90% by November 2008 (3) before mounting a comeback. A weak market didn't help, either.