During periods of heightened uncertainty on Wall Street, it's not uncommon for investors to seek safety in profitable, time-tested, outperforming businesses. While the "FAANG stocks" have been somewhat of a mainstay for investors over the past decade, it's companies enacting splits that have been garnering plenty of attention over the past two years.
A stock split allows a publicly traded company to alter both its share price and outstanding share count without affecting its market cap or operating performance. Think of it as a purely cosmetic change that can either make a company's shares more nominally affordable for retail investors, or increase a company's share price to ensure it meets the minimum listing standards of a major stock exchange.
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Most investors are laser-focused on forward-stock splits, which involves reducing a company's share price and increasing its share count by the same factor. Companies enacting forward-stock splits are usually highfliers that have handily outperformed and out-innovated their competition.
Since the midpoint of 2021, nine industry leaders have conducted forward-stock splits, including:
- Nvidia (NVDA 6.18%): 4-for-1 split
- Amazon (AMZN 3.43%): 20-for-1 split
- DexCom (DXCM -9.90%): 4-for-1 split
- Shopify (SHOP 1.11%): 10-for-1 split
- Alphabet (GOOGL 10.22%) (GOOG 9.96%): 20-for-1 split
- Tesla (TSLA -1.11%): 3-for-1 split
- Palo Alto Networks (PANW 0.91%): 3-for-1 split
- Monster Beverage (MNST 0.41%): 2-for-1 split
- Novo Nordisk (NVO 0.84%): 2-for-1 split
However, Wall Street's outlook for these companies varies greatly. Whereas select analysts and pundits believe three of these stock-split stocks could deliver triple-digit gains, a couple of Wall Street analysts foresee sizable declines for two of these nine high-profile stock-split stocks.
Tesla: Implied downside of 89%
The stock-split stock that offers jaw-dropping downside, at least in the eyes of GLJ Research's Gordon Johnson, is electric-vehicle (EV) maker Tesla. Johnson, a longtime Tesla bear, has a split-adjusted price target on the world's largest automaker by market cap of $24.33. If this price target were to come to fruition, it would represent an 89% decline from where Tesla stock closed on October 19.
Although Tesla is North America's leading EV manufacturer, and the company looks to be working on its fourth consecutive year of profitability -- something no other EV pure-play has come close to achieving -- there are a number of potential warning signs for current and prospective shareholders.
To begin with, Tesla kick-started a price war earlier this year that's proving disastrous to its margins. The company's four production models (S, 3, X, and Y) have endured more than a half-dozen price cuts. According to CEO Elon Musk, Tesla's pricing strategy is entirely driven by demand. Multiple price cuts signal that inventory levels are rising and/or demand for EVs remains tepid. Unsurprisingly, Tesla's operating margin has plunged from 17.2% to 7.6% over the past year.
As I've stated in the past, leadership is another reason to be cautious with Tesla. Despite being a visionary, Musk has also proved to be a significant liability for his company. He's drawn the unwanted attention of securities regulators on a number of occasions, and has made countless promises that simply haven't been fulfilled. For instance, Musk's pledge of Level 5 autonomy coming "next year" is something we've heard for the past decade.
Furthermore, Tesla has struggled to become more than a car company. Energy generation and storage revenue has practically flatlined over the past couple of quarters, while SolarCity has been a money-loser since it was acquired in 2016. This is a big problem for a company with a price-to-earnings (P/E) ratio of nearly 70, based on Wall Street's consensus earnings in 2023. By comparison, most auto stocks have P/E ratios of between 5 and 10.
There's no question Tesla has broken down barriers in the auto space and used its first-mover advantages to the fullest. But with competition picking up and the company's operating margin plunging, "down" is the likeliest direction Tesla stock is headed.
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Palo Alto Networks: Implied downside of 11%
The other stock-split stock at least one Wall Street analyst believes could head meaningfully lower is cybersecurity company Palo Alto Networks. Though some analysts foresee Palo Alto stock rising by more than 30% from its closing price of around $253 on Oct. 19, analyst Joshua Tilton of Wolfe Research expects shares to tumble by 11% to $225.
The likeliest reason Palo Alto Networks would find its shares under pressure is its valuation. During periods of economic uncertainty, investors gravitate to perceived-to-be "cheap" stocks. Palo Alto certainly isn't cheap by any traditional measuring stick. Based on Wall Street's consensus earnings estimate, shares are trading at nearly 48 times forecast earnings for fiscal 2024 (Palo Alto's fiscal 2024 ends on July 31, 2024).
The other potential concern would be the growing likelihood of a U.S. recession. With numerous economic datapoints and predictive tools forecasting weakness in the coming quarters, there's the worry we could see businesses pare back their spending.
However, cybersecurity solutions have evolved into necessity services. No matter how well or poorly the U.S. economy is performing, businesses with an online or cloud-based presence still need to protect their sensitive information. For cybersecurity companies like Palo Alto, it's led to highly predictable cash flow in any economic climate.
Furthermore, Palo Alto Networks has well-defined competitive edges in cybersecurity. Over the past five years, the company has made a concerted push toward cloud-based, artificial intelligence (AI)-driven, software-as-a-service (SaaS) solutions.
A portfolio focused on cloud-based SaaS offers a number of advantages. Cloud-based SaaS is going to be nimbler and more efficient at recognizing and responding to potential threats than on-premises solutions. Likewise, a subscription-driven operating model should do a much better job of retaining customers, lifting the company's operating margin, and delivering highly predictable cash flow. In other words, this shift is providing more bang for each revenue buck that Palo Alto Networks is bringing in.
Palo Alto's management has also done a fantastic job of making bolt-on acquisitions that expand its service ecosystem and move the profit needle higher.
While it's always possible Palo Alto could sell off with the broader market and reach Tilton's price target, this is a company whose tools and intangibles suggest it's headed considerably higher.
