Earlier this month, Amazon (AMZN 0.17%) announced that its Board of Directors approved a 20-for-1 stock split. The company has only split its stock four times in its history, with the last split occurring in 1999.
Amazon is just the latest big-tech and FAANG member to announce a split. Alphabet notified investors about a 20-for-1 split earlier this year, while Apple and Tesla completed stock splits during 2020, and Nvidia split its stock in 2021.
Investors may be considering whether to invest now, before the split or wait until the split occurs. Let's dig in and take a look at Amazon's valuation and learn why now may be the most prudent time to buy some shares.
What are stock splits?
It's important to note that stock splits don't fundamentally change anything about a company's operations or performance. When a stock split occurs, the number of outstanding shares increases by a certain multiple. As a result, the company's share price drops in proportion to that ratio so that the overall value doesn't change.
For example, if you own five shares of stock in a company that issues a 5-for-1 stock split, your position will increase to 25 shares after the split occurs. Now, let's say those original five shares held were $20 each, after the split each share becomes valued at $4. However, the total value of those shares remains the same (in this case $100) because stock splits don't inherently increase the value of a company.
Investors know that emotion can outweigh logic in the capital markets. For this reason, stock prices often rise before a stock split occurs. Investors will sometimes buy up a stock before the split occurs because they're hedging their bets that after the split goes into effect and the shares appear "cheaper," more investors will pour into the stock, thus increasing the price in a short period of time.
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Buy now or later?
Apple's most recent stock split was announced on July 30, 2020. On a split-adjusted basis, Apple's stock was trading at roughly $96 per share on the day it announced its stock split. By mid-August, the stock increased 20% to $115 per share.
Apple's stock split went into effect on Aug. 31, 2020, and over the next month, the stock price decreased from roughly $134 per share to $115 per share by the end of September 2020. It's possible that investors who bought the stock before the split rode its momentum and liquidated their positions after the stock split actually occurred, to lock in some short-term gains.
Similarly, Tesla announced its most recent stock split on Aug. 11, 2020. On a split-adjusted basis, the company's stock was trading for nearly $275 per share. By Aug. 21, 2020, the stock had risen a whopping 49% to $410 per share.
By the time the stock split went into effect on Aug. 30, 2020, Tesla's stock had risen to nearly $500 per share yet settled at around $430 per share one month later in mid-September that year. Again, investors may have been riding the short-term momentum leading up to the split and sold shares once the split occurred.
Amazon announced its stock split plans on March 9, 2022, when its stock was trading below $2,800 per share. As of March 29, Amazon's stock has risen 20% to about $3,400 per share. Investors can see that Amazon's stock price has followed a similar pattern to that of Apple and Tesla post stock split announcement.
Analyze the fundamentals
Famed hedge-fund manager Daniel Loeb, a major investor in Amazon stock, boldly declared that he sees $1 trillion of untapped value in the company -- telling investors that he thinks the market is conflating Amazon's two core operations: e-commerce and its cloud unit, Amazon Web Services (AWS). For this reason, he believes that the stock is fundamentally undervalued as it doesn't fully reflect the value of the company's market-leading, high-margin cloud segment.
Amazon's market capitalization is $1.7 trillion, which Loeb believes to be roughly 30% undervalued. For the year ended Dec. 31, 2021, AWS generated $62.2 billion of revenue, representing a 37% year-over-year increase. Furthermore, AWS generated $17.8 billion of revenue in the final quarter of calendar 2021 alone, putting it on an annual run rate of over $70 billion in revenue.
If we estimate that AWS is worth 30% of Amazon's current market capitalization, that would imply that the cloud unit alone could be worth $500 billion today. In addition to its growth in the cloud, Amazon has a number of other growth levers that could be taking market share away from big-tech incumbents.
The company recently gained approval for its proposed acquisition of MGM, which could further bolster Amazon's presence in entertainment and gain market share from incumbents such as Netflix and Disney. Furthermore, the company's advertising unit is growing over 30% sequentially and on a run rate of approximately $40 billion in revenue, likely providing a challenge to heavily ad-reliant Meta Platforms and Alphabet.
Since Amazon's last split in September 1999, the company's stock has soared by over 4,700%. While there's certainly a possibility to generate some profit in a relatively short timeframe leading up to the split, there are several reasons why investors may want to consider buying and holding now, before the split occurs in June.
As the company continues gaining momentum in advertising and entertainment, while also dominating in the cloud, there could very well be a lot of untapped value yet to be reflected in the stock. Therefore, buying pre-split with the intention to hold over a long-term horizon may be most beneficial for investors.
