With so much momentum in both Teslain (NASDAQ: TSLA) share price and its underlying businesses, is it a good time for the automaker to consider splitting its shares again?
Believe it or not, it has only been six months since Tesla surprised investors with a 5 by 1 stock split announcement. Despite the stock split in fifths, its price has already risen to more than half of its pre-split value in last August. In addition, it is not just stocks that have been gaining momentum since last summer: sales for the electric car maker have increased and profitability now looks like it’s here to stay. These may be signs that the growth stock may suffer another split this year.
Before we get into that, let’s cover some basic principles.
Image source: Tesla.
What is a stock split?
First, it is worth explaining exactly what a stock split is. The most important thing to know about a stock split is that it does not technically make investors richer and does not give the company whose shares are being split any incremental capital. A stock split is simply the division of one share into several new shares with a value totaling the original share.
You still don’t understand? Try this analogy: suppose you own a Tesla share. Now view this share as a complete pizza. Then someone comes over and cuts the pizza in four. Although you now have a sliced pizza, the total amount of food remains the same. The same is true for the total value of a shareholder’s ownership in a company before and after a 4-by-1 stock split.
The critical conclusion here is that a stock split does not create shareholder value. Sure, Tesla’s stock has risen sharply since its recent split – but that doesn’t always happen after a stock split. The increase in Tesla’s shares is due to business performance, including strong sales growth and increased profitability. In addition, the company simply grew up with analysts and Wall Street and became a stock market darling.
Why a Tesla stock split in 2021 is possible
Companies generally do not consider a subsequent stock split unless several things happen. First, shares must trade significantly higher than the previous split. After all, one of the main reasons why companies share their shares is to make them more accessible to retail investors. This makes the company’s shares more liquid and accessible to more investors.
Tesla certainly meets that criterion. Since the company announced a stock split last August, shares have risen nearly 200% on a split-adjusted basis. Today, shares are trading at a high price of more than $ 800 – well beyond the average share price of most companies.
Image source: The Motley Fool.
Another good argument for another stock split is Tesla’s strong commercial progress recently. If the rise in stocks was based solely on hot air, there is no way of telling how long stocks could remain at their high levels. And if the stock had a good chance of losing all of its recent earnings, why split the stock again?
Fortunately, Tesla’s underlying business appears to be firing on all cylinders. Deliveries of 12-month vehicles at the time of the Tesla stock split announcement were around 388,000. Today, that number is 500,000. In addition, management has directed deliveries in 2021 to exceed 750,000, showing how the company still appears to be at the beginning of its growth history.
Finally, Tesla’s quarterly free cash flow and available cash increased from $ 418 million and $ 8.6 billion in the second quarter of 2020 to $ 1.9 billion and $ 19.4 billion in the fourth quarter 2020, respectively, providing the company with much healthier financial results today.
Of course, Tesla investors should not expect a stock split in 2021. There is simply no telling when the car and green energy company will be able to split its shares again – if it will. In addition, there is no reason to be enthusiastic about a possible share split, as this does not create any shareholder value. However, there appears to be a growing case for another stock split.