Tallahassee Journal

Netflix’s stock split may be bad news

Netflix’s stock split may be bad news

Stocks are lower Wednesday but shares of Netflix (NFLX) are bucking the trend. Netflix soared to a new all-time high in early trading before falling back later in the trading as the streaming video provider announced a seven-for-one stock split, effective on July 15. I believe the market has it wrong — the stock split is neutral with regard to the shares’ intrinsic value, and I’d argue it’s actually bad news for long-term shareholders.

Let me say at the outset that I think Netflix is a extraordinary company, with a management that is capable, shareholder-friendly, and focused on running the business for long-term success. Which is why I’m surprised to see this stock split. First, let’s agree that a stock split has absolutely zero impact on shares’ intrinsic value. The analogy of the pizza pie is simple but effective: The act of slicing it into eight slices instead of four does not create any extra pizza. (Not to mention the fact that the split was widely anticipated.)

In its press release, Netflix did not cite a reason for the split, but Bloomberg reported that CEO Reed Hastings told investors at Netflix’s annual meeting earlier this month that a lower share price would render the stock more accessible. No one can argue with that, but what goes unsaid is that what you gain in accessibility you might lose in terms of the quality of investors you attract. The distinction here is not between large and small investors, but of investors with a long-term orientation versus those with a short-term mind-set.

In October 2013, Hastings hinted to investors that Netflix’s share price might have become disconnected from its intrinsic value. “Every time I read a story about Netflix is the highest appreciating stock in the S&P 500 it worries me, because that was the exact headline that we used to see in 2003. We have a sense of momentum investors driving the stock price more than we might normally,” he warned.

I’m convinced that phenomenon is more likely to occur with a stock that is more “accessible” and more “liquid” (the other benefit executives invoke in justifying a stock split). Netflix shares are already highly volatile, and there is no reason to create an incentive to add to that volatility. Refraining from splitting the stock is one of the few levers management has to discourage momentum “investors” from trading their stock, which, in turn, encourages market price formation that is more tightly aligned with intrinsic value. It’s a shame Netflix just relinquished that lever, just as another highflier, Apple (AAPL), did with its seven-for-one stock split a year ago.

Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool recommends Apple and Netflix. The Motley Fool owns shares of Apple and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.