Since the beginning of 2022, investors have contended with a challenging environment on Wall Street. All three major U.S. stock indexes have fallen into a bear market, with growth stocks getting hit especially hard. Worse yet, the near-term outlook for equities isn't all that promising.
Worse yet, the near-term outlook for equities isn't all that promising. According to the recently released minutes from the March Federal Open Market Committee meeting, the U.S. is forecast to enter a mild recession later this year. Even though the U.S.
S. economy and Wall Street don't move in tandem, two-thirds of the S&P 500's peak drawdowns over the past 95 years have occurred during, not prior to, a recession being declared.
Stock-split stocks have been investors' safety blanket during volatility
When the going gets tough on Wall Street, investors often turn to tried-and-true stocks that have a history of outperforming the broader market. During last year's tumult, it was stock-split stocks that rose above the pack to garner investors' attention.
A stock split is an event that allows a publicly traded company to alter its share price and outstanding share count without having an impact on its market cap or operations. Forward stock splits lower a company's share price while increasing its outstanding share count by an equal magnitude.
Forward stock splits lower a company's share price while increasing its outstanding share count by an equal magnitude. Meanwhile, a reverse stock split is designed to increase a publicly traded company's share price while reducing its outstanding share count by the same factor. Forward stock splits tend to get the most attention given that the companies enacting them are usually firing on all cylinders and out-innovating their competition.
Last year featured quite a few brand-name forward stock splits. Should a U.S.
S. recession take shape, one high-flying stock-split stock looks like a surefire buy, while another widely owned stock-split stock can be easily avoided.
The stock-split stock to buy hand over fist if a recession materializes: Palo Alto Networks
If you're looking for a stock-split stock you can buy with confidence no matter how well or poorly the stock market performs, cybersecurity company Palo Alto Networks (PANW -4.13%) fits the bill. Palo Alto completed a 3-for-1 forward split in mid-September.
The evolution of cybersecurity solutions to a basic necessity service is one reason Palo Alto Networks is such a safe play during a recession.
The evolution of cybersecurity solutions to a basic necessity service is one reason Palo Alto Networks is such a safe play during a recession. Hackers and robots aren't going to take time off from trying to steal sensitive information just because the U.S. economy hits a speed bump. With more data than ever being transferred online and into the cloud in the wake of the COVID-19 pandemic, companies like Palo Alto are finding their services increasingly in demand.
What's allowing Palo Alto to shine on a company-specific basis is its transition away from physical firewall solutions and toward cloud-based software-as-a-service (SaaS) solutions.
What's allowing Palo Alto to shine on a company-specific basis is its transition away from physical firewall solutions and toward cloud-based software-as-a-service (SaaS) solutions. This shift has been ongoing for more than four years. Since the end of fiscal 2018 (Palo Alto's fiscal year ends July 31), the percentage of net sales derived from subscriptions and support has increased from 61. 7% to 78.8%, as of the end of the fiscal second quarter of 2023 (Jan. 31, 2023).
There are a number of advantages to focusing on cloud-based SaaS solutions. For one, it allows Palo Alto to remain competitive with other cybersecurity providers. Even though physical firewall solutions remain in demand, cloud-based cybersecurity solutions that lean on artificial intelligence (AI) and machine-learning technology are almost always nimbler than on-premises security solutions and better able to respond to potential threats.
A second reason to focus on SaaS solutions, which builds on the first point, is revenue retention. Palo Alto is much likelier to keep cloud-based SaaS subscribers during an economic rough patch than it would be to hang onto buyers of its firewall products.
Palo Alto is much likelier to keep cloud-based SaaS subscribers during an economic rough patch than it would be to hang onto buyers of its firewall products. Shifting its net sales toward SaaS should result in more predictable operating cash flow, regardless of how the U.S. economy is performing.
And third, cloud-based SaaS typically offers much juicier margins than traditional firewall products. Focusing its attention on next-generation solutions should expand Palo Alto's operating margin over time.
Focusing its attention on next-generation solutions should expand Palo Alto's operating margin over time. It's worth noting that the company upped its fiscal 2023 operating margin by a full two percentage points to a range of 21.5% to 22% following the release of its fiscal second-quarter results.
Furthermore, while Palo Alto Networks has had no trouble adding new subscribers, the most impressive aspect of its growth has been netting the big fish. The total value of deals secured that total at least $10 million practically tripled on a year-over-year basis (up 196%), as of Jan. 31, 2023.
Palo Alto CEO Nikesh Arora has done a masterful job of navigating an already challenging economic environment and continues to add to his company's ecosystem by making bolt-on acquisitions. Despite a premium valuation, Palo Alto Networks' operating performance shows it's worth every penny (and some).
The stock-split stock to avoid if a U.S. recession takes shape: Tesla
However, not all stock-split stocks are necessarily going to be winners if a U.
recession takes shape: Tesla
However, not all stock-split stocks are necessarily going to be winners if a U.S. recession takes shape. Despite creating plenty of buzz with its 3-for-1 forward stock split this past August, electric-vehicle (EV) manufacturer Tesla (TSLA 0.33%) would be best avoided if U.S.
S. economic growth shifts into reverse.
The one advantage Tesla brings to the table, relative to other EV makers, is that it's recurringly profitable, based on generally accepted accounting principles (GAAP). Even following its rough first-quarter operating results, Tesla has delivered three consecutive years of GAAP profits. Meanwhile, the EV divisions of most new and legacy automakers are bleeding red.
But unlike cybersecurity solutions, vehicles aren't considered a basic necessity.
But unlike cybersecurity solutions, vehicles aren't considered a basic necessity. Auto stocks are cyclical, which means we'd expect to see demand taper off for new and used vehicles during a recession. The auto industry's strong cyclical ties are why auto stocks trade at high-single-digit price-to-earnings ratios and not the price-to-earnings ratio of nearly 50 that Tesla was commanding immediately prior to the reporting its first-quarter operating results.
The biggest warning for investors that demand may already be waning can be seen in Tesla's vehicle-pricing activity. Tesla has reduced prices for its top-selling U.S.
S. models on five separate occasions since 2023 began. Price cuts have been sizable outside the U. S. as well.
Although these price reductions have modestly impacted the company's inventory, Tesla's inventory hit 15 days' worth of sales at the end of the first quarter.
Although these price reductions have modestly impacted the company's inventory, Tesla's inventory hit 15 days' worth of sales at the end of the first quarter. That's the highest inventory build we've seen, relative to sales, since the third quarter of 2020. It implies that more price cuts may be on the way.
To add to this point, Tesla's key performance indicators have tumbled in the wake of these price cuts. The company's total GAAP gross margin plunged almost 10 percentage points year-over-year to 19.3%, while free cash flow plummeted 80% to $441 million.
3%, while free cash flow plummeted 80% to $441 million. Keep in mind that selling regulatory emission credits to other automakers accounted for $521 million in sales. In other words, sans regulatory emission credits, Tesla's operating divisions delivered an $80 million free cash outflow during the first quarter!
Another issue with Tesla is that its attempts to become more than just a car company have, thus far, failed. The company's solar panel installation, energy services, and supercharger/auto repair network are generating menial or negative gross margin and losing money once below-the-line expenses are factored in. Tesla's entire business is selling and leasing EVs, which will undoubtedly be hampered by a recession.
Lastly, my suspicion is that Wall Street will be less willing to put up with CEO Elon Musk's shenanigans during an economic downturn.
Lastly, my suspicion is that Wall Street will be less willing to put up with CEO Elon Musk's shenanigans during an economic downturn. There is a mountain of promises from Musk baked into Tesla's valuation -- but the vast majority of these promises haven't been met. Since investors tend to be more mindful of traditional valuation metrics during a recession, a company like Tesla, which continually kicks the can on promised innovations, could come under serious pressure. .