This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
Key Points
- Investors tend to cheer stock splits.
- There is some evidence that stocks outperform following a split.
- Netflix has one of the highest share prices on the stock market.
Stock splits don't change the fundamentals of a stock, but they still have a way of getting investors excited and capturing media attention.
First and foremost, stock splits tend to represent milestones in a stock's growth. They signal that management is confident enough in the business to lower the individual share price, effectively resetting shares for another run higher. There's also some evidence that stocks tend to outperform following a split.
According to research from Bank of America going back four decades, stocks that underwent a split rose 25.4%, more than doubling the return of the S&P 500 at just 11.9%, as the infographic below shows.
Image source: Statista.
That pattern seems to be evidence of correlation rather than causation. After all, companies are free to decide when they split their stocks, and they're more likely to do so when they're confident that the price will continue to rise. And splits are more common in bull markets, especially during surges like the dot-com boom. They're rarely seen during bear markets.
Given the propensity for outperformance following a stock split and the fact that the share price is lowered, benefiting retail investors, it's not surprising that the moves tend to attract so much attention.
One top stock that could be next in line for a split is Netflix (NASDAQ: NFLX), the streaming giant that has bucked the broader malaise in the entertainment industry to deliver monster returns over the last three years.
Netflix's shares are now hovering around $1,200, giving it one of the highest share prices in the S&P 500. The company is set to report fourth-quarter earnings on Oct. 21, and that could serve as an opportunity to announce a split since companies often choose to time them with earnings reports.
The case for a Netflix stock split
Netflix's 400% gain over the last three years hasn't come by accident. The company has delivered strong growth on the top and bottom lines as initiatives like advertising, paid sharing, and live events have resonated with its audience.
Advertising in particular has opened up a new revenue stream, giving it a way to grow without adding new subscribers or raising prices. It's also given Netflix cover to raise prices on premium tiers because it now has lower-priced ad-driven tiers for subscribers on a budget.
While some high-priced stocks have historically avoided stock splits, that isn't the case with Netflix. The company issued a 7-for-1 stock split in 2015, and a 2-for-1 split before that in 2004. Both times, the individual share price was much lower than it is today.
There's also another less obvious reason that a stock split would benefit Netflix. A lower share price would make the stock eligible to join the Dow Jones Industrial Average. At a market cap of $500 billion, Netflix is now much larger than many of the stocks in the Dow, and its industry -- entertainment -- is arguably underrepresented on the blue-chip index. While Disney is a member, no other Dow stocks derive a majority of their business from media or entertainment.
Is Netflix a buy?
Netflix isn't a member of the "Magnificent Seven," but it's outperformed many of those high-profile tech stocks in recent years. Nearly all of those have had stock splits in recent years, so it seems like Netflix is due.
When it reports third-quarter earnings on October 21, analysts expect revenue to grow 17% year-over-year to $11.5 billion. Earnings per share should increase from $5.40 to $6.94.
The stock isn't cheap at a price-to-earnings ratio of 50, but it dominates global video entertainment, and it still has a long runway of growth thanks to advertising and its local content strategy, which should drive further gains.
A stock split could help kick off the next leg up for Netflix stock.
This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
