With so much momentum in both Tesla's (TSLA -1.92%) stock price and its underlying business, is it a good time for the automaker to consider splitting its stock again?
Believe it or not, it's only been six months since Tesla surprised investors with a 5-for-1 stock split announcement. Despite the stock splitting in fifths, its price has already appreciated to more than half of its pre-split value last August. In addition, it's not just the stock that has seen momentum since last summer: The electric-car maker's sales have surged, and profitability now looks like it's here to stay. These may be signs that the growth stock could see another split this year.
Before we get into it, let's tackle some basics.
Image source: Tesla.
What's a stock split?
First, it's worth explaining exactly what a stock split is. The most important thing to know about a stock split is that it technically doesn't make investors any wealthier and doesn't give the company whose shares are being split any incremental capital. A stock split is simply a division of one share into multiple new shares with a value totaling the original share.
Still don't get it? Try this analogy: Assume you owned one share of Tesla. Now visualize this share as one full pizza. Next, someone walks up and slices the pizza into quarters. While you now have a sliced pizza, the total amount of food remains the same. The same is true for the total value of a shareholder's ownership in a company before and after a 4-for-1 stock split.
The critical takeaway here is that a stock split doesn't create shareholder value. Sure, Tesla stock has risen sharply since its recent stock split -- but this doesn't always happen following a stock split. Tesla stock's rise is due to business performance, including strong sales growth and improving profitability. In addition, the company has simply grown on analysts and Wall Street and has become a stock market darling.
Why a Tesla stock split in 2021 is possible
Companies don't usually consider a follow-up stock split unless several things happen. First, the stock should be trading significantly higher than its previous stock split. After all, one of the primary reasons companies split their stock is to make shares more affordable to retail investors. This makes the company's shares more liquid and accessible to more investors.
Tesla certainly meets this criterion. Since the company announced a stock split last August, shares have risen almost 200% on a split-adjusted basis. Today, the stock is trading at a lofty price of more than $800 -- well beyond the average share price of most companies.
Image source: The Motley Fool.
Also making a good case for another stock split is Tesla's strong business progress recently. If the stock's rise was based solely on hot air, there's no telling how long shares could stay at their elevated levels. And if shares had a good chance of losing all of their recent gains, why split shares again?
Fortunately, Tesla's underlying business seems to be firing on all cylinders. Trailing-12-month vehicle deliveries at the time of Tesla's stock split announcement were about 388,000. Today, that figure is at 500,000. Further, management has guided for deliveries in 2021 to exceed 750,000, showing how the company still seems to be early in its growth story.
Finally, Tesla's quarterly free cash flow and cash on hand have risen from $418 million and $8.6 billion in the second quarter of 2020 to $1.9 billion and $19.4 billion in the fourth quarter of 2020, respectively, giving the company much healthier financials today.
Of course, Tesla investors shouldn't count on a stock split in 2021. There's simply no telling when the auto and green energy company might split its stock again -- if ever. Further, there's no reason to get excited about a potential stock split, as it doesn't create any shareholder value. Nevertheless, there does seem to be a growing case for another stock split.
