Stock split watch: Will ServiceNow be next?

Generally, stock splits mean that good things are happening for the company and investors are happy. An enterprise software company ServiceNow (NOW 1.16%) fits this description. Since the company went public in 2012, the company’s shares have increased by over 3,400%, much more than S&P500 he did at the same time. Currently trading at over $880 per share, this market powerhouse could be ready for its first-ever stock split.

Investors generally cheer on stock splits, which can attract new buyers for the stock. Here’s why ServiceNow may soon split its stock and whether investors should buy before it happens.

Stock split information peak

On the surface, stock splits lower a company’s stock price by proportionally increasing the number of shares outstanding.

Let’s say you have 10 shares of stock in a company that are trading at $100 per share. You would have $1,000. If the company does a 2-for-1 stock split, you will now have a total of 20 shares at $50 each. Note that your stake is still worth $1,000, but there are now more shares at a lower price.

Stock splits help investors AND company employees. Many investors would rather own 100 shares of a company than just a few. However, most retail investors do not have the resources to buy many shares for hundreds of dollars each. Splits therefore have a psychological benefit that can encourage greater investment in the company.

Rather, it is about liquidity for the company’s employees, who receive compensation in the form of shares. Long-term employees may have large amounts tied up in company stock, so the split increases their share count, making it easier for them to control how many shares they sell when they get paid.

Why ServiceNow may soon split its stock

As I said, stock splits usually occur after sustained success that increases the value of the company enough that the split makes sense. ServiceNow is up more than 3,400% to nearly $900 per share and has entered potential stock split territory. It also hasn’t split its shares since going public, which means many employees likely have large sums tied up in their shares.

A stock split may be imminent as the company’s strong prospects signal greater returns in the future, which will only cause the share price to rise faster as the numbers grow. In other words, stocks at $80 and $800 may increase by 20%, but the move from $800 to $960 is more noticeable than the move from $80 to $96.

ServiceNow sells digital transformation software that helps companies streamline data and automate tasks and processes as they modernize. It can turn inefficient, piecemeal operations into fast, optimized and simplified ones.

Revenue NOW (TTM), YCharts data; TTM = final 12 months.

ServiceNow has more than 8,100 customers worldwide and is growing sales by more than 22% year over year, approaching $10 billion in annual revenue. The business is highly profitable, has strong earnings growth and a fortress-like balance sheet of approximately $4 billion in net cash (total cash less debt).

Given its solid financials and strong growth momentum, I don’t think it’s an exaggeration to say that the company’s stock will continue to rise over time, assuming it remains flat over the years.

Can you buy shares today?

Because stock splits have no impact on a company’s value, investors should never buy or sell stock based solely on the split.

Instead, compare the stock’s value to the company’s growth potential and see if there is good momentum. ServiceNow is currently trading at 63 times estimated 2024 earnings, a significant premium to the broader stock market.

However, analysts estimate that over the next three to five years the company will increase profits by an average of 32% annually.

A price-to-earnings (P/E) ratio of twice the company’s expected earnings growth is reasonable, especially considering ServiceNow’s financial profile. Simply put, it’s a high-quality growth company that Wall Street generally doesn’t mind paying a little more for.

ServiceNow isn’t a bargain, but its reasonable price should mean the company will not just outgrow its share price in the coming years, making it a viable investment idea today.