Should Ulta Beauty Split Its Stock?

In a note released on Monday, Loop Capital Markets said it believes Ulta Beauty Inc ULTA is overdue for a stock split given its view that a stock split will increase the company's attractiveness to individual investors.

Stock Split May Serve Ulta Beauty Well

Analyst Anthony Chukuma roots for a 5-for-1 or 10-for-1 split, as he thinks it will significantly increase its liquidity, thereby serving as a positive catalyst. Substantiating his claims, the analyst noted that Ultra Beauty shares average daily volume was 636,000, which is a fraction of the volume of comparably sized market capitalization retailers such as Dollar General Corp. DG, Dollar Tree, Inc. DLTR and Best Buy Co Inc BBY.

Stock Split: The Science And Logic

A stock split is a decision by a public company to split its share in order to increase the number of outstanding shares. Companies split their shares when their stock price is excessively high, putting it beyond the reach of retail investors. Thus, by splitting shares, companies make their shares affordable for retail investors, although status quo is maintained with respect to the underlying valuation.

The 5-for-1 or the 10-for-1 ratio recommended by Loop Capital Markets would mean four new shares would be issued for every one share held or nine new shares would be issued for every one share held.

Will the split boost share price? The answer is yes. Studies show that when a company splits its shares, the share price rises by an average of 7 percent in the first year after splitting and 12 percent after three years, Investopedia said.

In June 2015, Netflix, Inc. NFLX offered a 7-for-1 split, as the stock galloped to nearly $700.

Kroger Co KR announced a stock split, also in 2015, for the first time in 16 years. The company also opined that through the split, it wishes to make its stock more affordable to its employees.

However, stock splits are losing relevance in present day investing, which is dominated by institutional investors and exchange traded funds, the Bloomberg said in a report.

Another way of increasing liquidity and marketability of shares is the issuance of different classes of common stock. In the 1990s when Berkshire Hathaway Inc. (NYSE: BRK-A) (NYSE: BRK-B)'s shares were trading at a price in excess of $22,000, the company issued 517,500 Berkshire Hathaway Class B shares, worth 1/30th of a Class A share but 1/10,000th of the voting right.

Although Warren Buffett has refrained from splitting the Class A shares despite their astronomical prices, he announced a 50-for-1 split for the Class B shares in 2010.

Compelling Fundamental Story

Meanwhile, Loop Capital Markets believes Ulta Beauty is the most compelling fundamental story in retail. Among the drivers, the firm outlined were:

• Beauty industry growth and market share expansion due to new product introductions.
• The continued rollout of in-store prestige boutiques.
• The company's robust "Ultamate Rewards" customer loyalty program.
• Continued heady e-commerce growth.

The firm also see the struggles that high-end department stores such as Macy's Inc M, Neiman Marcus and Nordstrom, Inc. JWN as positives for Ulta Beauty. Additionally, the firm expects the strong e-commerce growth to continue.

As such, the firm upgraded Ulta Beauty to Buy from Hold and increased its price target to $350 from $285, implying 23 percent upside from current levels.

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