Investors love stock splits. it doesn't actually make the company worth more -- you don't have more pizza if you cut those eight slices into 16 -- but it does buoy sentiment. And at least short term, the shares of companies that announce them tend to jump. The implication is that any board of directors authorizing a split knows the company is strong and the future is bright. It can also serve a real purpose for compensating employees.
Recently, two tech titans that many thought might never split their stock said they would do just that. In early March, Amazon announced a 20-for-1 stock split. It followed Google's parent Alphabet doing the same a month earlier. If you're wondering about the next candidate for a big announcement, Chipotle Mexican Grill (CMG 2.41%) checks all of the boxes. These charts show why.
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A high stock price
In the past five years, shares of Alphabet and Amazon have risen 265% and 240%, respectively. Chipotle is in the same neighborhood at 257%. At $1,600, Chipotle shares have also reached a point where one share costs a sizable chunk of change. And management has never split the stock.
It not only makes it less accessible for investors with small portfolios -- including many of its young customers -- it also makes it more difficult to reward employees with equity in the company.
In 2018, Chipotle awarded all of its 71,000 qualified employees with some combination of a one-time cash bonus and stock grant. Shares traded below $300 then. Awarding a dedicated hourly worker $300 is a lot more complicated with the stock price where it is today.
A strong business
Having a high stock price is one factor to consider for a stock split. But a strong business is also required. A stock split should send the message that the company is financially sound. After several food safety issues over the past decade, the company seems to be back on the right track.
In 2020, Chipotle agreed to pay the biggest federal fine of its kind ever to resolve criminal charges over food safety issues between 2015 and 2018. The increased safety protocols have dented profit margins. But they are still strong and headed in the right direction.
CMG Operating Margin (TTM) data by YCharts
A positive outlook
The most important factor to consider for a company thinking about splitting its stock is the outlook. The last thing any management team wants is to split the stock and then have it drop as the business struggles.
For instance, Countrywide Financial, the subprime lender at the center of some of the most questionable loan practices leading up to the financial crisis, split its stock in 2004. So did Bank of America. In 2006, Wells Fargo had a stock split. That's not great timing in hindsight for banks that would soon experience collapse.
The outlook for Chipotle appears to be bright. In fact, over the past several years, the estimates for the current- and following-year revenue have consistently risen with the small exception of the beginning of the coronavirus outbreak.
CMG Revenue Estimates for Next Fiscal Year data by YCharts
There's good reason for the optimism. Management now believes it can open at least 7,000 locations in North America. That's up from the 6,000 it previously committed to. It attributes the increase to the success of restaurants in smaller towns. On top of that, Chipotle plans to accelerate expansion. It now believes it can increase store count 8% to 10% per year. The icing on the cake is that 80% of those new locations are expected to have a drive-thru, called a Chipotlane. Having one increases the profitability of a location.
For Chipotle, the most important numbers are heading in the right direction. And the company isn't just expanding -- it's accelerating. With a share price nearly 100 times the average hourly wage and a tight labor market, it may be time to split the stock and once again offer employees a share of ownership in the company.
