It’s been a busy year on Wall Street. Investors are grappling with the highest US inflation rate in four decades (9.1% in June 2022), Russia’s invasion of Ukraine and a wrench into global oil and gas supplies and the US economy, which has tumbled back-to-back quarters of the year Gross domestic product supplies (GDP) falls. Although the US is not officially in a recession — an eight-person panel of economists makes that assessment — two consecutive quarters of GDP contraction are widely viewed by the investment community as a “technical recession.”
But despite this economic and stock market turmoil, investors became obsessed with stock splits. A stock split allows a publicly traded company to change its stock price and the number of shares outstanding without affecting its market capitalization or its operations.
A forward stock split can lower a company’s stock price to make it nominally more affordable for investors without access to fractional stock purchases. A reverse stock split can raise a company’s stock price to ensure that it meets the minimum stock price requirements to remain listed on a major stock exchange.
Since the beginning of the year, dozens of stocks have split their shares. Among these numerous stock split stocks are two companies that have never been cheaper and one that is a value trap to be avoided like the plague.
Stock Split Stock #1 to Buy Hand Over Fist: Amazon
A common stock that’s long overdue to split up and looks cheaper than ever as a public company is e-commerce stocks Amazon (AMZN 3.53%). The company announced a 20-for-1 forward split in March and completed its split with shareholder approval on June 6.
Amazon is the kingpin of online trading companies. A March report from eMarketer estimated that the company would drive a whopping 39.5% of all online retail spending in the U.S. by 2022. For comparison, that’s over 8 percentage points more market share than Amazon’s 14 closest competitors combined. In other words, Amazon’s leadership in the online marketplace is not going to be questioned anytime soon.
While Amazon’s online marketplace generates the majority of the company’s sales, it’s perhaps its least important business segment from a profitability standpoint. Far more important is how this leading segment has helped Amazon grow more than 200 million Prime members worldwide. Assuming each member pays the $139 annual fee, Amazon amass nearly $28 billion each year in high-margin revenue that it can channel into its logistics network or other fast-growing initiatives.
Not only is the company the leading online marketplace, but its Amazon Web Services (AWS) drove an estimated 33% of global cloud services spend in the first quarter, according to a Canalys report. We’re still early in the cloud growth cycle, and margins associated with cloud services can orbit margins associated with online retail sales. Though AWS contributes 15% to 16% of Amazon’s net sales, it regularly accounts for well over half of the company’s operating income.
While Amazon isn’t exactly cheap based on its projected earnings, it is is decidedly cheap compared to Wall Street’s projected cash flow for the company. After Amazon was valued between 23 and 37 times year-end operating cash flow in the 2010s, investors can buy shares of the online retailer for about 10 times projected cash flow through 2025.
Stock split stock #2 to buy Hand over fist: Alphabet
The second stock-split stock that’s just never been cheaper for investors is alphabet (GOOGL 2.63%) (WELL 2.68%), the parent company of internet search engine Google, streaming platform YouTube and self-driving car maker Waymo. Back in February, Alphabet announced its intention to conduct a 1:20 stock split. The company completed its demerger on July 18, following the approval of its shareholders.
The Internet search engine Google has been the company’s anchor for more than two decades. It’s a virtual monopoly, as Google has controlled at least 91% of global internet search for the last two years. Because Google is the search platform of choice, parent company Alphabet can have excellent pricing power when negotiating with retailers.
But much like Amazon, it’s no longer the fundamental segment that Wall Street and investors are enamored with. Rather, they’re fascinated by the many projects Alphabet is pouring all of Google’s operating cash flow into.
For example, YouTube has become one of the most popular social websites in the world. Approximately 2.48 billion people visit YouTube monthly, giving the company a lot of power in ad pricing. YouTube subscriptions also add to the revenue stream and keep active viewers loyal to the brand.
Google Cloud represents another high-growth segment that may be critical for Alphabet over the long term. Canalys notes that Google Cloud consumed 8% of global cloud services spending in the first quarter. Though Google Cloud is losing money for Alphabet right now, the hefty margins associated with cloud services should help this segment become a consistent moneymaker for years to come.
Over the past five years, Alphabet’s stock has averaged more than 26 times annual earnings and over 19 times cash flow. Investors can buy Alphabet shares for less than 20 times Wall Street’s forecast earnings for 2023 and just nine times projected cash flow by mid-decade.
The stock split value trap to avoid like the plague: SNDL
However, not all stock split stocks are sound investments. A perfect example of a stock split stock that screams “value trap” is Canadian licensed marijuana stocks SNDL (SNDL 5.95%).
SNDL, formerly known as Sundial Growers, issued a 1:10 reverse split on July 26th. With its shares trading between $0.30 and $0.83 over the past year, SNDL required a reverse split to meet the minimum listing price on the Nasdaq stock exchange. While not all stocks that do reverse splits are automatically companies to avoid, a company with a low share price usually has headwinds that get it there.
SNDL has been a particular favorite of meme stock traders and early cannabis investors because the company has a solid cash balance. While funding has been challenging for a number of Canadian pot stocks, SNDL ended March with CA$511.3 million (US$397.9 million) in cash, restricted cash and marketable securities.
On the other end of the spectrum, it had no debt and around $207 million in short- and long-term lease commitments. It’s a cash-rich company viewed as value by retail investors looking for momentum. Unfortunately, SNDL is nothing more than a value trap.
Effective October 1, 2020, the management team of SNDL began issuing common stock to raise enough capital to become debt free. The thing is, management never turned off the faucet. The company continued to dilute its shareholders throughout 2021, long after it had enough capital to pay off its debt.
On a pre-split basis, SNDL’s share count rose from 509 million to an almost unfathomable 2.33 billion. Even after the reverse split, SNDL will struggle to post meaningful earnings per share.
To make matters worse, SNDL’s management raised capital with no really defined purpose. Although the company eventually made some investments/acquisitions with its capital, management has never made clear its intentions with its incessant capital raising (ie, dilution) activities.
The final drop is that the Canadian pot market has been a disaster. Federal and provincial regulators (in Ontario at least) have been slow to approve key licenses, while consumers have gravitated toward value-based dried cannabis, as opposed to the higher-margin pot products that licensed producers were counting on.
With the company running out of cash quickly and the U.S. appearing no closer to legalization under President Joe Biden than it did under former President Donald Trump, SNDL has all the hallmarks of a stock-split value trap to avoid like the plague.