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Netflix (NASDAQ: NFLX) has been one of the hottest stocks of 2015. It’s up nearly 100% for the year and is regularly setting new all-time highs.
So, with its strong performance year-to-date, it might seem odd that Netflix is currently pursuing a stock split.
At Netflix’s annual shareholder meeting Tuesday, shareholders voted to approve a share authorization to increase the number of Netflix shares outstanding – a necessary step for a stock split. Shareholders voted to increase the number of shares that management may issue by nearly 30 times.
Of course, stock splits shouldn’t matter.
If you have two shares worth $50 each, you own $100 worth of that company. After a 5-for-1 stock split you would have 10 shares worth $10 each. You would still own $100 worth of that company and the stock split would not increase your stake in the company or change the company’s total market value.
But there’s a reason why companies run by intelligent people continue to pursue stock splits. A lower price tag on a stock can make an otherwise “expensive” stock seem more palatable to investors. So stock splits do seem to matter.
Consider that shares of Apple (NASDAQ: AAPL) rose more than 20% in just the month and a half between when the company announced its 7-for-1 split and when the split took effect. The stock is now up an additional 40%.
Surely we can’t chalk all of Apple’s share price appreciation to a stock split. But the split was part of a catalyst that ignited the rally.
In the case of Netflix’s stock, which closed Wednesday trading at $671.10 per share, the logic behind a stock split is that the high sticker price might be scaring off certain investors.
Rational? No. But stocks and entire markets are frequently irrational.
According to Nasdaq.com figures, Netflix is currently trading at around 400 times 2015 earnings. Though rapid earnings growth means the stock is trading at “just” 182 times 2016 earnings, this is still a ridiculously steep valuation.
By comparison, the Warren Buffett favorite Coca-Cola (NYSE: KO) trades at just 20.5 times 2015 earnings and 19.15 times 2016 earnings.
I can’t argue that Netflix’s stock is a bargain. But a Netflix stock split could very well fuel the next move higher for the stock.
Netflix shareholders approved an increase in the number of shares outstanding from 170 million to 5 billion. That means Netflix could split its stock by as much as 29-for-1, a move that would lower Netflix’s share price dramatically.
Remember that the split wouldn’t actually change the value of Netflix as a whole. But, based on Wednesday’s closing price of $671.10 per share, a 29-for-1 Netflix stock split would make each split-adjusted share just $23.14.
Let us know what you think of stock splits in the comments section below. Do they make a difference in a stock’s performance or are they as pointless in reality as they are in theory?
In the case of the Netflix stock split and how the market will react, only time will tell. You can be sure that we’ll revisit the question once the market has spoken.
DISCLOSURE: I personally own shares of Apple.
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