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Stock splits generally garner a lot of attention from the investment community. In fact, stocks that have undergone a split witness increased levels of trading activity immediately after the event.
In recent years, several high-profile technology companies including Tesla, Nvidia, Broadcom, Amazon, Apple, and Alphabet have undergone stock splits.
Here’s what investors need to know about stock splits, and why I think Netflix (NFLX -1.01%) could be a candidate to split its shares sooner rather than later.
How do stock splits work?
Stock splits sound complicated, but rest assured that the mechanics around a split are easy to understand.
When a company announces its plan to split its stock, it will also share an important ratio with investors. For example, if a company says it is going to execute a 10-for-1 split, all this means is that the outstanding share count will rise by a factor of 10, while the stock price is reduced by that same factor of 10.
Since the number of outstanding shares and the stock price are changed by the same factor, the valuation of the business (i.e., its market cap) remains unchanged.
What’s the significance?
After a split, investors often perceive the lower share price as more affordable. For this reason, stocks after a split tend to witness greater demand, resulting in the share price continuing to gain.
Ironically, this means that many investors may actually end up paying for the stock at a higher valuation post-split versus where the stock was trading before the split took effect.
Image Source: Getty Images
Why it makes sense for Netflix to split its stock
In 2024, shares of Netflix soared by 86% — almost triple the gains witnessed in the S&P 500 (SNPINDEX: ^GSPC) and Nasdaq Composite (NASDAQINDEX: ^IXIC). As I write this, the stock price of $904 is inching toward an all-time high.
NFLX data by YCharts.
In the chart above, I’ve illustrated the entire history of Netflix’s stock price and annotated the graph with the company’s stock split history. Since going public, it has split its stock on two occasions (the purple circles with the letter “S”).
The last split was in July 2015. Since then, the stock has risen by more than tenfold.
Considering shares are within shouting distance of $1,000 and the momentum currently looking unstoppable, I wouldn’t be surprised if some investors are seeking alternatives in the media and entertainment space given the pricey nature of Netflix.
To me, the recent valuation expansion in Netflix stock, as seen above, could dissuade investors from buying the stock. For this reason, I would not be surprised to see management opt for a stock split in the near term.
Split or not, Netflix is a great opportunity
It’s important to note that a stock split in Netflix is purely speculation on my end. Just because I think such a decision makes sense, that doesn’t mean it’s going to happen.
Although the company’s forward price-to-earnings multiple of 38 isn’t exactly a bargain, I think the premium is warranted. The company’s recent expansion into live sports events as well as its upcoming immersive-experiences project, dubbed Netflix House, show me that the company is looking to diversify its platform beyond producing original content and licensing popular syndicated shows and movies from distributors.
Regardless of whether or not a split occurs, I still see Netflix as a great opportunity for long-term investors to buy and hold.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Adam Spatacco has positions in Alphabet, Amazon, Apple, Nvidia, and Tesla. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Netflix, Nvidia, and Tesla. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
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