Now don’t look at Wall Street’s broadest stock indexes, the benchmark S&P500 and growth-oriented Nasdaq Compositeare back in correction territory, as of the closing bell on October 27.
When times get tough on Wall Street, investors typically seek the safety of profitable, proven, better-performing companies. Over the past two years, this definition perfectly encompassed a handful of companies that implemented stock splits.
A stock split is an event that allows a publicly traded company to cosmetically change its stock price and the number of shares outstanding without any impact on its market capitalization or operating performance. A forward-stock split lowers a company’s stock price, making it more affordable for ordinary investors who don’t have access to fractional share purchases from their online broker.
Meanwhile, reverse stock splits increase a publicly traded company’s stock price, usually with the goal of ensuring that it meets minimum listing standards for a major stock exchange.
Image source: Getty Images.
Forward stock splits often catch the attention of investors. That’s because companies that implement forward splits are often industry leaders and top-tier innovators, whose high-flying stock prices reflect this outperformance relative to their peers.
Since the beginning of July 2021, nine high-flying companies have split their shares:
While all nine of these companies offer easily identifiable competitive advantages, their prospects for the next five to ten years vary widely. As we approach November, one of these nine stock splits is actually cheaper than it has ever been as a publicly traded company – while another stock split looks entirely avoidable as it faces mounting headwinds.
The stock split to be handed over in November: Alphabet
The screaming bargain in November, among the aforementioned nine stock split stocks, is Alphabet. This is the parent company of the well-known internet search engine Google and streaming platform YouTube, among others.
If there’s a weakness in Alphabet’s armor, it’s that the company is cyclical. Nearly 78% of the total revenue of $76.7 billion reported in the quarter ended September came from its advertising services. Advertising is notoriously cyclical, with companies reluctant to cut spending at the first sign of economic weakness. Given that a handful of economic data points and forecasting tools signal a coming recession, it’s possible that Alphabet’s main source of revenue could weaken in the coming quarters.
But this is a two-sided coin, and the two sides are not even equal.
While U.S. recessions are a completely normal part of the economic cycle, they are traditionally short-lived. Only three of the twelve post-World War II recessions lasted at least twelve months, and none of the remaining three lasted longer than eighteen months. In the meantime, most expansion periods have lasted longer than a year. In other words, the advertising industry is poised to flourish over time.
Few companies are better positioned to benefit from long-winded economic expansions than Alphabet. Google accounted for nearly 92% of the global Internet search share in September 2023, and has collected at least 90% of the global Internet search share every month since April 2015. It’s the undisputed go-to for businesses looking to advertise, which means Google has exceptionally strong power in ad pricing.
In addition to its bread-and-butter cash flow driver, Alphabet should see meaningful growth from YouTube and Google Cloud. The former is the second most visited site worldwide and has seen the daily number of short videos, known as Shorts, increase over the past two years.
Google Cloud is a particularly intriguing long-term growth catalyst. Spending on enterprise cloud services is still in its early stages, and Google Cloud already accounts for an estimated 9% of spending on cloud infrastructure services, based on a second-quarter report from technology analytics firm Canalys. Although Google Cloud’s year-over-year growth rate has “slowed” to 22.5%, it has generated three consecutive quarters of operating profits as of the quarter ended September after years of losses.
Most importantly, this undisputed market leader is virtually much cheaper than it ever was as a publicly traded company. Shares of Alphabet can now be purchased for less than 13 times consensus cash flow per share in 2024. By comparison, the company’s shares have averaged a multiple of just over 18 times year-end cash flow between 2018 and 2022 .
Alphabet is a surprisingly cheap stock that patient investors can buy hand over fist with confidence.
The Model 3 is Tesla’s best-selling sedan. Image source: Tesla.
The stock split to avoid in November: Tesla
However, past performance does not guarantee future success. In November, electric vehicle (EV) maker Tesla stood out as the clear stock split worth avoiding.
Tesla has done a number of things right to be valued as the world’s largest automaker by market capitalization. It became the first automotive company in over fifty years to build itself from scratch to mass production, and is currently the only pure EV manufacturer to generate recurring profits based on Generally Accepted Accounting Principles (GAAP). Although older car manufacturers are quite profitable, the EV divisions of older car companies are bleeding red.
Likewise, Tesla is sitting on a real pile of cash. It ended the quarter ended September with $26.1 billion in cash, cash equivalents and investments. With a fairly minimal amount of debt, Tesla has more flexibility to innovate and potentially diversify its business than its peers.
But Tesla also has plenty of disadvantages as an investment.
For example, it lacks brand power. It is a relatively young brand that is clearly in the background General engines And Ford Motor Company, to name a few. With more than a century of history behind them, these stalwarts can easily bridge generational gaps to connect and engage past and future buyers.
Tesla also seems to have a pretty serious inventory problem. Since the end of the first quarter of 2022, days of supply – that is, the end of new car inventory divided by the deliveries of the relevant quarters – have increased from three days to 16 days, as of September 30.
CEO Elon Musk has previously stated that Tesla’s pricing strategy is dictated by demand for its electric vehicles. With more than six price cuts across the four production models since the start of 2023, the implication is clear that inventory is an issue. Not surprisingly, these price cuts have more than halved the company’s operating margin over the past year, from 17.2% to 7.6%.
Tesla’s attempts to become more than just a car company aren’t exactly a success either. The SolarCity acquisition has been a money loser for Tesla for seven years, while Tesla’s remaining side businesses are generally low-margin. In fact, revenue in the company’s Energy Generation and Storage segment has remained relatively flat since the first quarter of this year.
To build on the above, 41% of Tesla’s pre-tax profit in the last quarter can be traced to interest income from its cash and automotive credits, which it sells to other automakers. These sustainable energy credits are provided to Tesla by governments free of charge. This is a significant amount of pre-tax income that has nothing to do with selling and leasing electric vehicles.
Finally, Tesla’s valuation makes little sense. Auto companies typically trade at a price-to-earnings (P/E) ratio in the mid to high single digits. Tesla has a price-to-earnings ratio, based on consensus 2023 earnings, of well above 60. With operating margins declining, Tesla appears to be at risk of a serious downturn.
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Suzanne Frey, a director at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Sean Williams has positions at Alphabet and Amazon. The Motley Fool holds positions in and recommends Alphabet, Amazon, Monster Beverage, Nvidia, Palo Alto Networks, Shopify, and Tesla. The Motley Fool recommends DexCom, General Motors, and Novo Nordisk and recommends the following options: Long January 2025 $25 calls on General Motors. The Motley Fool has a disclosure policy.
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