Whenever a company announces plans for a stock split, the market generally cheers the news -- but why?
Technically, a stock split only divides shares into smaller ownership stakes of the company -- like a cutting pie into more slices, it doesn't change anything about the overall size of the pie, nor the value of the company. Still, these financial maneuvers can serve a purpose. By increasing the share count and lowering the share price, they can make it easier for retail investors to buy or sell the stock.
Market high-flyers Nvidia and Broadcom split their stocks earlier this year after their respective share prices soared to more than $1,000.
Another artificial intelligence company, Palantir Technologies (PLTR -2.01%) has outperformed both of them since the start of last year, soaring by more than 1,000%. Should investors expect a stock split from Palantir next?
Why do companies split their stock?
Companies do stock splits for several reasons.
First, they make a stock more liquid (easier to buy or sell). For investors, that means they can accumulate more shares without needing tons of capital. Meanwhile, company employees who want to sell shares they have received as stock-based compensation love a split because it gives them more control over how they liquidate their shares. For example, would you rather have 10 shares worth $1,000 to sell or 100 shares worth $100 each? Having 100 smaller shares gives you more flexibility in terms of how and when you cash out.
Next, a stock split sends a confident message to the market: "Hey, investors -- things are going well, and management thinks they will continue to do so." Stock splits may not in any direct way impact a company's fundamentals or valuation. Still, investor sentiment impacts short-term stock prices, and make no mistake: Most corporate management teams care about sentiment and share prices.
Is Palantir a stock-split shoo-in?
On the surface, it would make sense for Palantir to engage in a stock split. For a company's market cap to rise by 1,000% in only two years is remarkable. Nvidia and Broadcom performed similarly, and both did split their stocks. However, Palantir is far from guaranteed to follow them.
Making it easier for average investors to buy or sell a stock is arguably the primary value of a stock split, and Palantir shares are already comfortably priced. The company went public via a direct listing in late 2020 at a reference price of $7.25 per share. Today, it trades at around $70 per share. That's far higher than it was, but it's nowhere near $1,000, and not so high that the price tag would hinder individual investors from accumulating a meaningful number of shares or require employees to sell their stock in inconvenient chunks.
A mismatch between Palantir's market cap and its fundamentals
Stock splits make the most sense after years of success have made a stock (and its underlying business) so large that a split would reset the share price to a number that works for all would-be buyers and sellers.
To be fair to Palantir, the company has made strides. Its Artificial Intelligence Platform has ignited a wave of growth, highlighting the company's tremendous opportunities in the AI software space. It has deep ties to the U.S. government and is quickly expanding its client base in the private sector. The business has turned GAAP profitable, and analysts believe its earnings will grow by an average of 36% annually for the next three to five years.
Unfortunately, the market has seemingly priced all that anticipated success and then some into the stock already. Shares trade at an eye-popping 187 times Palantir's estimated 2024 earnings. Its price-to-sales ratio has soared to 64, well beyond its peak during the tech market bubble of 2020 and 2021. These valuations appear unsustainable and will likely drag on the stock eventually.
So, what would a stock split accomplish? The share price is still low enough to accommodate almost all buyers and sellers, and there's a realistic chance the stock will pull back anyway.
Ultimately, a stock split doesn't make much sense for Palantir. I'd be shocked to see the company announce one anytime soon.
