For 15 months, investors have been taken for quite the ride, courtesy of Wall Street. Following 2021, which saw the S&P 500 endure a peak correction of just 5%, the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite took a shellacking in 2022. All three fell into a bear market and generated their worst yearly returns since the Great Recession.

But even in down years for the stock market, investors find bright spots to latch onto. In 2022, it was stock-split stocks.

Stock splits take center stage
A stock split is an event that allows a publicly traded company to alter its share price and outstanding share count without having any effect on its market cap or operations. A forward stock split is designed to make a company’s share price more nominally affordable for everyday investors, whereas a reverse stock split increases a company’s share price, which is usually done to keep it compliant with minimum listing standards for a major U.S. stock exchange.

Most investors gravitate to companies enacting forward stock splits. That’s because forward stock splits are undertaken by businesses whose share prices have risen significantly. For a company’s share price to appreciate meaningfully over time, the underlying businesses has to be firing on all cylinders. In many instances, companies enacting forward splits are also out-innovating their competition. This makes forward splits something of a beacon for investors to locate top-tier businesses.

In 2022, a half-dozen prominent stocks conducted much-anticipated forward stock splits. This includes:

  • Amazon (AMZN -2.20%) completing a 20-for-1 split in June,
  • DexCom (DXCM 2.23%) enacting a 4-for-1 split in June.
  • Shopify (SHOP -1.26%) finishing its 10-for-1 split in June.
  • Alphabet (GOOGL -1.02%) (GOOG -0.78%) closing its 20-for-1 split in July.
  • Tesla (TSLA 1.24%) enacting a 3-for-1 split in August.
  • Palo Alto Networks (PANW 0.10%) completing its 3-for-1 split in September.

Among these six high-profile stock-split stocks, one stands out as a surefire buy for patient investors in April, while another is facing mounting headwinds and is worth avoiding.

The stock-split stock that’s a surefire buy in April: Palo Alto Networks
The stock-split stock that makes for a surefire buy this month is cybersecurity player Palo Alto Networks. Although Palo Alto is, arguably, pricier than the FAANG stocks that also split their shares (Alphabet and Amazon), its phenomenal growth rate and execution make it worth every bit of its premium.

Before digging beneath the surface, I believe its important to point out that cybersecurity solutions have evolved into basic necessity services over time. In the wake of the COVID-19 pandemic, businesses of all sizes have created an online presence and moved their data into the cloud. No matter what the U.S. economy throws corporate America’s way, demand for cybersecurity solutions to protect sensitive information isn’t going away.

With this macro tailwind in mind, the biggest company-specific catalyst in Palo Alto’s sails is its ongoing transformation to a cloud-based, subscription services-driven operating model. Though it hasn’t completely abandoned physical firewall solutions, emphasizing cloud-based software-as-a-service (SaaS) security solutions comes with well-defined advantages.

For one, subscription services tend to be stickier when it comes to customer retention. This is to say that subscribing customers are less likely to cancel their subscription(s) than a purchaser of physical firewall products is to buy new products. It’s a definite boost to long-term loyalty and gross revenue retention.

To add, an SaaS-driven model should also produce predictable cash flow on a quarterly/annual basis. Without much in the way of churn, Palo Alto’s management team can confidently outlay capital for innovation and acquisitions without hampering profitability.

There’s undeniable evidence that Palo Alto Network’s shift to cloud-based SaaS is paying off. Thanks to a larger percentage of net sales coming from SaaS solutions, the company has been able to sustain a growth rate in excess of 20%. Additionally, the company raised its operating margin guidance for fiscal 2023 in February by 200 basis points to a range of 21.5% to 22%, relative to what it had forecast in November. It’s not just that next-generation software sales are accelerating — it’s that sales are accelerating in all the right (i.e., higher-margin) places.

What’s particularly noteworthy is the growth in Prisma Cloud, the company’s inline network security solution designed to protect developers in public and private clouds. As of the January-ended quarter, the number of subscribers using four or more Prisma cloud module solutions rose 114% year-over-year. The strength of next-gen solution add-on sales demonstrates why Palo Alto is firing on all cylinders.

With Palo Alto Networks focused on high-margin SaaS solutions and continuing to make smart bolt-on acquisitions, its current share price premium will look like a discount when looking back in a few years.

The stock-split stock you can avoid in April: Tesla
But not all stock-split stocks will continue to be winners for investors. Out of last year’s high-profile stock splits, it’s electric-vehicle (EV) manufacturer Tesla that I’d suggest avoiding in April.

Make no mistake about it, Tesla didn’t reach a $587 billion valuation by accident. It’s been propelled by its first-mover advantages in the EV space. It’s North America’s leading EV producer, with the company nearing 441,000 total EVs produced during the first quarter. Thanks to two new gigafactories coming online last year, the company believes it’ll reach 1.8 million EVs produced in 2023, with some pundits on Wall Street thinking Tesla could hit 2 million.

Investors have also been enamored with Tesla’s profits. Based on generally accepted accounting principles (GAAP), it’s delivered a profit in each of the past three years. That’s in stark contrast to the EV segments for virtually every other new and legacy automaker, which are bleeding red.

CEO Elon Musk has played a role in sending Tesla’s stock higher, too. Musk is viewed as an innovator, and his promises of innovations to come have been built into his company’s valuation.

While this story has fanned the flames of bulls for years, a growing number of headwinds should have investors hitting the brakes on the world’s most-valuable automaker.

To begin with, Tesla’s price cuts look like a clear red flag. Though some people will argue that these cuts are in response to manufacturing becoming more cost-efficient, they’ve corresponded with rising inventory levels for the company. Ongoing price cuts in the U.S., China, and Europe suggest Tesla’s vehicle margin will contract meaningfully in 2023 (if not beyond) as competitors close the gap.

Another reason to be concerned is that all of Tesla’s efforts to become more than just a car company haven’t yielded favorable results. Musk’s acquisition of SolarCity has been a money-loser since day one. Meanwhile, the company’s energy and services divisions are generating menial gross margins that ultimately turn to losses once below-the-line expenses are factored in. Ultimately, Tesla is a car company that’s valued at 48 times Wall Street’s consensus earnings in 2023. For context, auto stocks usually have earnings multiple of between 6 and 8.

But the biggest reason to avoid Tesla stock is its leadership. Aside from the fact that Musk has found himself in potential hot water with securities regulators on more than one occasion, he’s made a laundry list of promises that have failed to come to fruition. Level 5 autonomous driving has been “a year away” for nine years and counting, while not one of the 1 million promised robotaxis is on public roads. Everything from promised EV models to ancillary innovations are regularly delayed by Musk and his team.

With a possible U.S. recession on the horizon, an exceptionally pricey (and cyclical) auto stock led by questionable management isn’t where I’d want my money to be.

— Sean Williams

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Source: The Motley Fool