When the curtain closes on 2022 in less than three months, it may well go down as one of the worst years for Wall Street in history. The benchmark S&P 500, which is typically viewed as the most encompassing barometer of stock market health, delivered its worst first-half return since Richard Nixon was president. The Dow Jones Industrial Average and Nasdaq Composite haven't fared any better, with both indexes mired in a bear market.
Yet amid this turmoil, investors have found a bright spot with stock-split stocks.
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Stock-split euphoria has taken over Wall Street
A "stock split" is a mechanism that allows a publicly traded company to alter its share price and outstanding share count without affecting its market cap or operations. A forward stock split, which is what tends to excite investors the most, reduces a company's share price while increasing the outstanding share count by the same factor. Meanwhile, a reverse stock split increases a company's share price while reducing its outstanding share count by the same magnitude.
One of the reasons investors like forward stock splits is because they make shares more nominally affordable. Investors who don't have access to fractional-share purchases through their online broker might have to save up a lot of money before being able to buy a single share of a high-priced stock. However, a forward split reduces the share price of high-flying stocks, thereby making them more affordable for everyday investors.
Another reason stock-split stocks are so popular is the fact that they're almost always outperformers. A publicly traded company wouldn't be conducting a forward stock split if its share price hadn't risen significantly -- and its share price wouldn't have risen had it not executed well and out-innovated its competition. In other words, stock splits act like a beacon to notify investors of top-performing companies.
More than 200 splits have occurred this year. Among this long list is a stock-split stock that has all the tools and intangibles needed to make its shareholders richer, as well as another popular stock that should be avoided at all costs.
The stock-split stock to buy hand over fist: Palo Alto Networks
Out of the numerous well-known companies that enacted stock splits this year, the one that's begging to be bought by investors during the bear market decline is cybersecurity stock Palo Alto Networks (PANW -1.22%). Palo Alto completed a 3-for-1 stock split on Sept. 14, 2022 (the company's first split since going public in July 2012).
The beauty of the cybersecurity industry is that it's evolved into a basic necessity over the past two decades. No matter how poorly the U.S. economy or stock market is performing, hackers and robots don't take time off from trying to steal sensitive data. This means businesses big and small have become more reliant on third-party cybersecurity solutions as enterprise data shifts online and into the cloud. In short, not even a recession would be expected to slow demand for cybersecurity solutions.
To add to the above, the COVID-19 pandemic has broadened Palo Alto's addressable market. Although some workers have returned to the office, a hybrid work environment that features a substantial number of remote workers is the new normal. This means more emphasis than ever will be placed on protecting data in public clouds.
On a more company-specific basis, it's Palo Alto's four-year (and counting) operating transformation that should have its shareholders excited. This transformation has seen the company shift its focus to cloud-based software-as-a-service subscriptions and away from physical firewall products. Over the past five fiscal years (Palo Alto's fiscal year ends on July 31), the company's share of sales derived from subscriptions and services has increased from just shy of 60% to a little over 75%. The company's annual growth rate has accelerated as well.
Subscription-based revenue tends to be more predictable and generates better operating margins than physical firewall products. Additionally, shifting to a subscription-driven operating model should demonstrably reduce the revenue lumpiness associated with physical firewall product replacement cycles.
Palo Alto has also done a bang-up job of incorporating bolt-on acquisitions. Regularly buying smaller businesses has helped Palo Alto Networks expand its next-generation service offerings, and it provides a means to cross-sell its solutions while reaching new customers.
Palo Alto's growth is accelerating at a time when everything else seems to be decelerating, which is what allows it to stand out as a no-brainer stock-split stock to buy right now.
A Tesla Model S charging. Image source: Tesla.
The stock-split stock to avoid like the plague: Tesla
But there are two sides to this stock-split euphoria. Though it's the most popular stock on the planet for Robinhood's retail investors, electric vehicle (EV) manufacturer Tesla (TSLA -1.92%) is the stock-split stock worth avoiding at all costs. Tesla completed a 3-for-1 stock split in late August.
To be fair, Tesla wouldn't have surpassed a $1 trillion market cap and become one of the largest publicly traded companies in the world if it wasn't doing something right. It's the first automaker in over half a century to have successfully built itself from the ground up to mass production. It's also shifted to recurring profitability over the past two years.
What's more, the Tesla faithful appreciate what CEO Elon Musk brings to the table. Musk has overseen the launch of four EVs and anticipates the Semi and Cybertruck going into production in the not-so-distant future. Additionally, he's diversified Tesla's core business to including energy storage products and solar panel installation. However, these positives no longer outweigh the many negatives Tesla is contending with.
The most-glaring issue with Tesla has to be its valuation. Though the company does generate revenue from solar panel installation and energy storage products, the bulk of its sales come from selling EVs. With the auto industry being highly cyclical, most auto stocks are valued at a high single-digit forward price-to-earnings (P/E) ratio. Tesla's forward P/E is about 38.
While some folks would point to Tesla's faster growth rate as justification for this higher forward P/E ratio, they're forgetting that Tesla is subject to the same cyclical pain as traditional auto stocks. Historically high inflation and persistent supply chain problems, coupled with the likelihood of reduced demand for new autos as interest rates soar, are all headwinds that could slow production and/or deliveries for Tesla.
But the biggest issue of all might just be Elon Musk. Putting aside the fact that his offer to acquire social media platform Twitter has been a distraction, Musk has a terrible habit of overpromising and underdelivering. From level five full self-driving technology to robotaxis on our roads, virtually every claim that Musk has made as to when a new technology or innovation would be available hasn't been met. Considering that Tesla's valuation has been built atop these promises, it puts the company's nearly $700 billion market cap on very shaky ground.
