Stock-Split Watch: Is Palo Alto Networks Next?

Palo Alto Networks (PANW -2.67%), one of the world’s largest cybersecurity companies, has only split its stock once since its initial public offering (IPO) in 2012. That 3-for-1 stock split occurred after the market close on Sept. 13, 2022.

Before that split took effect, Palo Alto Networks’ stock closed at $548.88 per share. It opened at $183.75 the following day, and eventually doubled to an all-time high of $376.90 on Feb. 9, 2024. It currently trades in the low $330s.

Should investors expect this bellwether of the cybersecurity sector to split its stock again in the near future?

Do stock splits matter for long-term investors?

Stock splits often attract a lot of attention because they reduce the trading price of each share. Some smaller investors might consider that price reduction to be an opportunity to buy more shares of a stock that was trading at much higher prices.

Yet stock splits don’t actually make a company’s shares fundamentally cheaper, since they merely split one larger share into smaller slices. So instead of buying a whole pizza for $20, you’re merely buying a quarter-slice for $5. A stock’s key valuations — such as its price-to-earnings ratio or price-to-sales ratio — don’t decline after a stock split.

Stock splits were more meaningful when investors could only buy single shares of a stock. However, most brokerages now allow investors to trade fractional shares with zero commissions — so stock splits don’t matter as much as they used to.

Stock splits generally shouldn’t matter too much to long-term investors, but they still offer certain benefits for options traders and employees. Stock splits make options trading cheaper because each contract is tethered to 100 shares. That adds up quickly when the stock trades for hundreds of dollars per share. They can also make it easier for a company to pay its employees with more granular and flexible stock-based compensation plans.

Will Palo Alto’s stock soar higher and split?

Based on its previous split, Palo Alto might wait for its stock price to climb higher before it considers splitting its stock again. However, its slowing revenue, billings, and EPS growth over the past year suggests its upside potential might be limited.

Data source: Palo Alto Networks. YOY = Year-over-year. (Palo Alto’s fiscal year ends in July.)

Palo Alto operates three main ecosystems: Strata, which houses its older on-site firewalls and network security services; Prisma, which handles its cloud-based security services; and Cortex, which develops AI threat-detection algorithms. Most of its recent growth has been driven by Prisma and Cortex, which it calls its “next-gen security” (NGS) services, instead of Strata’s legacy products and services.

However, Palo Alto’s top-line growth cooled off, as macro headwinds made it harder to gain new customers and lock in higher-value contracts. It also faced fierce competition from Fortinet (FTNT 1.80%), which provides similar services powered by its own custom chips; CrowdStrike (CRWD 0.79%), which provides cloud-native services instead of using on-site appliances; and AI-driven challengers like SentinelOne (S 0.04%).

To fend off the competition, Palo Alto is rolling out more services that directly compete against those smaller-niche cybersecurity companies. It’s bundling them together with its core services in a “platformization” strategy, which it claims will drive away those competitors and stabilize its long-term growth — but it’s currently being driven by free trials and deferred revenue deals. In other words, Palo Alto is trying to widen its moat with loss-leading strategies.

For fiscal 2024, Palo Alto expects its billings to grow 10% to 11%, its revenue to rise 16%, and its adjusted EPS to increase 25% to 26%. Those growth rates are stable, but they’re not too impressive for a stock that trades at 53 times forward earnings. Fortinet, which is only growing at a slightly slower rate, has a lower forward earnings multiple of 37.

Don’t assume Palo Alto’s stock will rally and split

Palo Alto’s stock has rallied more than 10% over the past week, but those gains seem to have been driven by CrowdStrike’s disastrous outage in late July instead of any major news about the company. CrowdStrike’s misstep might gradually drive some companies toward other cybersecurity companies like Palo Alto, but its customers are still locked into its contracts, its cloud-based services are sticky, and switching costs are high.

Therefore, it’s still too early to assume that CrowdStrike’s pain will generate long-term gains for Palo Alto and its other competitors. So instead of wondering if Palo Alto’s stock will rally and split, investors should focus on its upcoming fourth-quarter report on Aug. 19 to see if it can stabilize its top-line growth with its risky platformization strategy.

If it fails to do so, its stock could easily lose its premium valuation and experience a post-earnings plunge. And that’s hardly the perfect setup for a stock split.

Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends CrowdStrike, Fortinet, and Palo Alto Networks. The Motley Fool has a disclosure policy.