Generally, stock splits mean that good things are happening for the company and investors are happy. Enterprise software company ServiceNow (NOW -0.48%) fits that description. The stock has appreciated over 3,400% since the company went public in 2012, miles beyond what the S&P 500 has done over the same time. Now trading at more than $860 per share, this market beater could be ripe for its first-ever stock split.
Investors generally cheer stock splits, and they can attract new buyers to the stock. Here is why ServiceNow could soon split its stock and whether investors should buy before it might happen.
The scoop on stock splits
At the surface level, stock splits lower a company's share price by proportionately increasing the number of shares.
Suppose you have 10 shares of a company trading at $100 per share. You would have $1,000. If the company executes a 2-to-1 stock split, you now have a total of 20 shares trading at $50 each. Notice how your stake is still worth $1,000, but now there are more shares at a lower price.
Stock splits help investors and company employees. Many investors would rather own 100 company shares than just a few. Yet, most retail investors don't have the funds to buy many shares at hundreds of dollars each. So splits have a psychological benefit that might entice more investment in the company.
It's more about liquidity for company employees who receive stock-based compensation. Long-term employees might have large sums tied up in company stock, so a split increases their number of shares, making it easier for them to control how many shares they sell at a time when they cash out.
Why ServiceNow could split its stock soon
As I said, stock splits generally come after sustained success increases a company's value enough that a split makes sense. ServiceNow has appreciated over 3,400% to nearly $900 per share and has entered potential stock-split territory. And it has not split its stock since going public, meaning many employees likely have large sums tied up in its stock.
A stock split could happen soon because the company's strong outlook signals more investment returns ahead, which will only jack up the share price faster as the numbers grow. In other words, a $80 stock and a $800 stock can both increase by 20%, but going from $800 to $960 pops more than going from $80 to $96.
ServiceNow sells digital transformation software that helps companies streamline their data and automate tasks and processes while modernizing. It can turn inefficient, fragmented operations into fast, optimized, and simplified ones.
NOW revenue (TTM), data by YCharts; TTM = trailing 12 months.
ServiceNow has more than 8,100 customers worldwide and is growing sales by more than 22% year over year as it approaches $10 billion in annual revenue. The business is highly profitable, with strong earnings growth and a fortresslike balance sheet with approximately $4 billion in net cash (total cash minus debt).
Given the robust financials and strong growth momentum, I don't think it's a stretch to say the stock will continue to go higher over time, assuming it continues executing as it has for years.
Is the stock a buy today?
Since stock splits don't affect a company's value, investors should never buy or sell a stock solely based on a split.
Instead, compare the stock's value to the company's growth potential and see if there's a good dynamic. Today, ServiceNow trades at 63 times its estimated 2024 earnings, a hefty premium to the broader stock market.
However, analysts estimate the company will grow earnings by an average of 32% annually over the next three to five years.
A price-to-earnings ratio (P/E) twice a company's anticipated earnings growth is reasonable, especially given ServiceNow's financial profile. Simply put, it is a high-quality, growing company, something Wall Street generally doesn't mind paying a bit more for.
ServiceNow isn't a bargain, but its reasonable price should mean the business more than grows into the stock's valuation over the coming years, making it a worthwhile investment idea today.
