Investors get excited about stock splits for two reasons. The most obvious reason is they reduce a company's share price, making the stock more accessible. The less obvious reason is they often spotlight strong businesses. To elaborate, forward stock splits are only necessary after substantial share price appreciation, which rarely happens to mediocre businesses.
Microsoft (MSFT 1.82%) and ServiceNow (NOW 1.02%) are prime examples of that concept in action. Their stock prices have soared 264% and 216%, respectively, over the past five years. In both cases, that price appreciation can be traced back to strong financial results.
Those gains made Microsoft and ServiceNow stock split candidates in 2024, but these two companies are worthwhile investments whether or not they split their stocks. Here's why.
1. Microsoft
Microsoft is well known for its Windows operating system, Office productivity software, SQL database, Azure cloud computing services, and Xbox hardware and gaming content. Indeed, the company enjoys a strong presence in each of those product categories, but its most compelling growth prospects lie in enterprise software and cloud computing.
Microsoft dominates the software-as-a-service (SaaS) market, earning nearly twice as much revenue as its closest competitor. That success is due to strength in productivity, cybersecurity, and communications applications (i.e., the Microsoft 365 suite) and enterprise resource planning applications (i.e., the Dynamics 365 suite). In a bid to create new revenue streams, the company has launched generative artificial intelligence (AI) copilots that automate workflows across those software products.
Meanwhile, Microsoft is gaining market share in cloud computing due in part to strength in artificial intelligence infrastructure and machine learning services. Microsoft Azure accounted for 24% of cloud infrastructure and platform services spending in the fourth quarter, up two percentage points from the prior year. Microsoft is well positioned to maintain that momentum due to its exclusive partnership with OpenAI, which lets Azure clients use models like GPT-4, the cognitive engine that powers ChatGPT Plus, to build custom applications.
Microsoft reported better-than-expected financial results in the second quarter of fiscal 2024 (ended Dec. 31, 2023). Revenue rose 18% year over year to $62 billion on particularly strong momentum in cloud computing. Meanwhile, non-GAAP net income soared 26% to $2.93 per diluted share.
Turning to the future, SaaS revenue is projected to increase at 13.7% annually through 2030, and cloud computing revenue is projected to grow at 14.1% annually during the same period. That gives Microsoft a good shot at low-double-digit sales growth through the end of the decade. Indeed, Wall Street analysts expect the company to grow sales at 14% annually over the next five years.
That consensus estimate makes its current valuation of 13.4 times sales appear tolerable, despite being a premium to the three-year average of 11.5 times sales. Patient investors should consider buying a small position in Microsoft today, whether or not the company splits its stock in the near future.
2. ServiceNow
ServiceNow helps businesses digitize and streamline processes across disparate departments and software systems. Its platform comprises applications that address four primary use cases: (1) technology workflows like IT service management, (2) customer workflows like customer and field service management, (3) employee workflows like human resources services, and (4) creator workflows like application development and workflow automation.
ServiceNow is a recognized leader in several relevant software categories, including enterprise service management, digital process automation, and low-code application development platforms for professional developers. In addition, the company placed No. 19 on the Future 50 list in 2023, an annual report compiled by Fortune and Boston Consulting Group that ranks the world's largest companies based on future growth prospects.
ServiceNow reported solid fourth-quarter financial results. Total revenue increased 26% to $2.4 billion and non-GAAP net income jumped 36% to $3.11 per diluted share. In addition, remaining performance obligation -- contracted revenue that has not yet been recognized -- increased 29%, signaling strong top-line momentum in the coming quarters. The company also achieved a renewal rate of 99% in the fourth quarter, up from 98% in the previous year, signaling a high degree of customer satisfaction.
Looking ahead, ServiceNow values its addressable market at $220 billion. The company is well positioned to capitalize on that opportunity given its strong presence in multiple software markets and investments in generative AI. To quote CEO Bill McDermott, "Generative AI is injecting new fuel into our already high-performing engine. ServiceNow's intelligent platform for end-to-end digital transformation is driving massive leaps in productivity and explosive growth. This is a breakthrough moment."
Wall Street expects ServiceNow to grow sales at 20% annually over the next five years. In that context, its current valuation of 17.6 times sales is tolerable, despite being a slight premium to the three-year average of 16.9 times sales. Investors with a five-year time horizon should feel comfortable buying a small position in this growth stock today, whether or not the company splits its stock in the near future.
