I recently had the opportunity to appear on the Road Dog radio channel on Sirius XM
While discussing potential profits in transport stocks -- UPS
Navistar, you see, sold for a hair less than $48 at the time of this interview. In contrast Sirius XM itself was selling for just a little more than $1. And the question arose: "Which would you rather own, a stock selling for $48 or one selling for $1?"
Which one, indeed.
Problem is, that's not the right question to ask. The price a stock sells for offers you almost no clue whatsoever of how much the company it represents is worth. The examples of Navistar and Sirius offer an especially good illustration, because Sirius, although selling for "only a dollar" a share, has 3.89 billion shares outstanding. In contrast, Navistar has only 71.7 million shares to its name.
Result: At $48 per share, times 71.7 million shares, Navistar is actually a cheaper company to own than Sirius. Its market capitalization of $3.5 billion is less than 70% the size of Sirius's $5.2 billion market cap.
If I had a nickel for every time someone told me that when a $1 stock "only goes to $10," you'll retire a millionaire … well, I'd have a lot of nickels. Sure, technically, the math is right. But the cold, hard truth is that it's as hard for a $1 stock to "go to $10" as it is for Navistar to move from $48 a share to $480.
To illustrate how this works, let's take a totally fictional company that sells Christmas wreaths over the Internet year-round: Piedmont International Evergreens (Ticker: PIE) has a $1 million market cap. With 10,000 shares outstanding, the market value of each share of PIE is $100.
At some point, Piedmont management decides it's not getting enough attention from investors and that the solution might be to lower the stock price. So PIE announces a 10-for-1 share split. Each existing share of PIE is going to be cut into 10 smaller slices, each priced at $1. If you owned a slice of PIE before the split, you owned a 0.0001% stake in the company. After the split, you will own 10 slices of PIE, but each one is worth only $1, so your ownership stake remains just 0.0001%.
See how this works? The stock price changed. The value of the company did not.
But here's the real question: Just because slices of PIE are selling for $1 apiece, does the chance that they will rise to $10 increase? I think not. It's still the same company. The economics of selling Christmas wreaths in the summer has not changed. Shoppers are no more likely to be thinking "evergreen" in July now than they ever were before. The only thing that's changed -- literally, the only thing -- is the price tag on these smaller pieces of PIE. For the new shares to "go to $10," PIE as a whole still needs to rise to a $10 million market cap, and that's no more likely today than it ever was.
Returning to Sirius
Now, on the other hand, it's also no less likely. After all, maybe I'm wrong about PIE. Maybe pine-fresh scents are popular this year, and the wreath market is ready to boom. After all, for years I was one of the staunchest critics of Sirius XM. I blasted the company for its lack of free cash flow. I pointed and gasped at management's gamble when it declined to purchase insurance against a catastrophic failure of its satellites.
Yet the more I look at Sirius today, the more I like it. Revenue growth is on a tear. The company recently joined the positive-free-cash-flow club. Analysts believe that the company's subscription-based revenue stream will help it to far outpace the growth rate of more mature media players such as Comcast
Granted, the stock sells for 35 times free cash flow even today, and it carries a hefty slug of debt that plumps its enterprise value even farther. But given the transition to free cash flow, the breakneck growth pace, and -- as fellow Fool Tim Beyers pointed out earlier this week -- the potential for further stock gains as institutional investors pile onboard, I actually do believe that Sirius offers investors a chance for big profits today.
But not because of the $1 stock price. In spite of it.
Fool contributor Rich Smith owns no shares of any company named above. FedEx and Netflix are Motley Fool Stock Advisor picks. UPS is a Motley Fool Income Investor selection. The Fool owns shares of FedEx and UPS.
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