Google's Next Move Should Be A Split

May.16.13 | About: Alphabet Inc. (GOOG)

On Wednesday, Google (NASDAQ:GOOG) raced through two milestones, crossing $900 a share and a $300 billion market cap. For the day, Google soared by nearly $29, a rise of 3.25%, to $915.89, closing just 50 cents or so from the daily high. Since Google reported fiscal first quarter results on April 18th, shares are up $150, nearly 20%.

It's been a remarkable rise for Google, as you can see from the chart below. Google actually missed on revenues at the Q1 report, and earnings beat substantially due to a much lower tax rate. Investors obviously see a promising future for Google, with shares up 65% from the 52-week low. At this point, it seems that Google is set to break $1,000, a target that many analysts currently have on the name. As Google breaks through on several new products and services, one must wonder what's next for the name. Today, I'll detail why I think the next thing investors should want is a stock split, and why it would be good for shares and the company.

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Getting more investors involved:

There's a theory that by splitting a stock, you open it up to more investors. Investors that might not want to buy a $500 stock could buy a stock that is at $50. There will be debates about this theory until the end of time, whether a split actually works in this manner.

So let's look at it this way. Let's say you are an investor with $10,000 and you want to allocate 15% of your portfolio to Google. Right now, that is rather difficult, and I'm talking about common stock here, not going into the world of options for this argument. At current prices, you have two choices. You could buy one share of Google for $915 or so, or two shares for more than $1,830. One share may not be enough for you, but two shares might be too much.

So in the following table, I've put together what a split would do for this investor. I'm going to assume that the $1,500 is a hard cap, and that no trading expenses are involved. The table shows a variety of ways Google could split, and how much extra money would be left after the maximum number of shares were purchased.

*Numbers may be slightly off due to rounding.

In this case, an 8 for 1 split would work the best, with a new share price a little under $115. I understand that Google might want to be seen with a bit of a "premium" stock price, so they might want to keep it at more than a few hundred. That's fine, but just look at a 2 for 1 split. You still get a lot closer to $1,500, and Google would still be trading at a price higher than Apple (NASDAQ:AAPL).

A mountain of expectations at higher prices:

I brought up Apple, and it is very relevant for this argument in my opinion. When Apple raced from $400 to $700, expectations increased to an unreasonable level. Obviously, with a higher stock price people were expecting more. When Apple initially pulled back to $650, everyone was asking "What's wrong with Apple?" As Apple continued to pull back, the questions piled up, and it seemed like something was seriously wrong with Apple. While results weren't great, I don't think that a pullback from $705 to $385 was completely warranted, but it happened.

If Google does break through $1,000 at some point, I feel like this same issue could happen with Google. What happens the first time when Google pulls back to $975, or even $950? Will there be "something wrong" with Google then? If it was over $1,000 and goes back down into triple digits, why did it not hold $1,000?

Plus, let's just hypothetically assume that Google splits 10 for 1. If Google were to decline from $95 to $90, would there be a lot of questions? Probably not. Even though the percentage terms are the same, a drop from $950 to $900 seems more dramatic. Google's near $29 rise on Wednesday seemed much bigger because it took out the following $5 levels: $890, $895, $900, $905, $910, $915. That seems important, but a rise of $2.90 or so today wouldn't have seemed as large. Bigger sometimes just seems better (or worse on the downside).

An eventual buyback:

I described the investor above trying to buy shares, now think about Google trying to buy them back. Eventually, Google will probably be buying back their shares, like Apple is now doing. For those that don't know, Google's share count is rising by the quarter, thanks to executive options dilution and the like. The chart below shows Google's diluted share count, as used for earnings per share purposes, over the last three years.

As you can see, Google shareholders are facing further dilution. That dilution is almost two percent in the past year, 4.36% in the past three years, and more than 6.1% in the past four years. It doesn't seem like much, but it adds up. You could make the argument that Google's earnings per share, and even share price, would be a bit higher if not for the dilution. Maybe Google would have already topped $1,000.

You would figure with Google's growth slowing down (more on this later) and its cash pile growing, a buyback will eventually come. Google had approximately $50 billion in cash, equivalents, and marketable securities at the end of Q1. As their 10-Q filing tells us, approximately $31 billion was held outside the United States, meaning that they have $19 billion inside the US. This is not an uncommon practice, as Apple has 2/3 of its cash and investments overseas. Eventually, shareholders will demand some of that cash, and a buyback will most likely occur.

The challenge of slowing growth:

One of the biggest reasons for Apple's fall from grace is its slowdown in growth. Apple has delivered weak guidance in recent quarters, causing revenue estimates to come down substantially. Everyone is concerned over Apple's growth, and the company will most likely report a year-over-year decline in earnings. Earnings per share might actually drop by 10% in this fiscal year.

Well, Google is about to see its revenues slow down quite a bit as well. In last year's Q2, Google reported its first quarter with included results from the Motorola Mobility acquisition. That gave revenues a nice boost for a couple of quarters, but it will lead to a slowdown in growth at this point. Also, be wary when you look at certain websites for growth numbers. Yahoo! Finance, for example, appears to show Google growing Q2 revenues at almost a 50% clip because they are comparing GAAP estimates to non-GAAP results. That's an apples to oranges comparison, and Google's Q2 revenue growth will probably be closer to 20%, and maybe lower than that.

One must start to wonder if the slowing growth that we are about to see with Google will hurt like it did for Apple. I'm guessing that we probably won't see a 45% decline in Google, but I wouldn't be surprised if we started to pull back a little. Don't forget, a $915 share price carries high expectations. If Google doesn't deliver, that price may not hold for long.

Final Thoughts:

Google raced through $900 on Wednesday, and $1,000 isn't too far off at this point. I think we've come to the point where a stock split would be the best thing for shares of Google and its public perception. We saw how big a fall could be when Apple raced above $700, and I don't think a repeat in Google would be pretty. A decline from $90 to $85 may not seem like much, but one from $900 to $850 seems like a fall.

At this point, Google could split its stock and still not have a massive amount of shares outstanding. A 3 for 1 split would mean a share count slightly above that of Apple. Even a 10 for 1 split would still leave Google with less than 3.5 billion shares, well below the counts from Microsoft (NASDAQ:MSFT), Intel (NASDAQ:INTC), and Cisco Systems (NASDAQ:CSCO). It would also make shares more accessible to investors, and easier for the company to buy back stock when the time comes.

As you can see from the chart below, Google and Apple have gone their separate ways over the past 6 months. Apple's bubble burst and shares dropped 45% in less than a year. Now Google is on the clock to see if its lofty levels can be sustained. One thing is certain in my opinion. It would be a lot easier to hold $90 than it would be to hold $900. I think it's time for Google to split, and I think it would be seen as a positive move for the name.

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(Author's note - all charts used are from Yahoo! Finance)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.