ACCA Advanced Financial Management (AFM) Practice Exam

On average, how do stocks perform in the year following a split?

1. Underperform the market

2. Outperform the market

3. Remain stagnant

4. Decline steadily

The correct answer is: Outperform the market

Historically, stocks tend to outperform the market in the year following a stock split. This phenomenon occurs for a few reasons. First, stock splits often signal to the market that a company is confident in its future growth prospects. When a company splits its stock, it usually does so because its share price has risen to a level that is perceived as too high for average investors to buy. Lowering the share price through a split makes the stock more accessible to a wider range of investors, particularly retail investors who may view the stock as more affordable. Second, there is a psychological effect tied to stock splits. Many investors might interpret a split as a positive indicator of a company's strength, which can lead to increased demand for the shares. This increased demand can drive the share price higher, contributing to the outperformance relative to the market. Finally, empirical studies have consistently shown that stocks that undergo splits typically see higher returns in the subsequent year compared to the overall market. This may reflect investor optimism and increased trading volume that often accompanies splits. Overall, the historical trends and behavior surrounding stock splits indicate that they usually lead to positive market performance in the year that follows.