In contrast to the stock-split frenzy of 2022 involving companies like Alphabet, Amazon, and Tesla, 2023 has seen relatively fewer stock splits. Nevertheless, some companies, such as Monster Beverage and Novo Nordisk, have undertaken splitting their shares this year.
Chipotle Mexican Grill (CMG 2.41%), a fast-casual Mexican restaurant with over 3,250 locations, is one company that could benefit from a split as its stock is close to $1,800 per share. Let's explore the possible implications of a stock split and whether Chipotle might contemplate such a decision.
What's a stock split?
A stock split is when a company increases its outstanding shares while preserving its market capitalization. For instance, if you own 10 shares of a company at $100 each, and the company enacts a 2-for-1 stock split, you'll then own 20 shares priced at $50 each.
It's crucial to understand that a stock split does not alter the value of your investment; it merely adjusts the number of shares you hold.
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Why would a company split its stock?
When a stock like Chipotle commands a high trading price, it may become unattainable for certain prospective investors. While fractional shares are accessible through many brokerages, some prominent ones, such as Vanguard, do not provide this feature. In theory, a lower share price could broaden accessibility, potentially boosting demand for the company's shares and consequently increasing its market capitalization.
A reduced stock price can also offer a company's employees increased flexibility in handling their equity. Elon Musk has previously argued that a lower stock price enhances a company's ability to both attract and retain talent, whether through equity compensation packages or employee stock purchase plans.
Finally, a higher stock price can also hinder a company's inclusion in a price-weighted index like the Dow Jones Industrial Average. That's because the value of a price-weighted index is determined from an average of the share prices of all the companies. Therefore, a stock like Chipotle is unlikely to be added because its high share price would significantly outweigh others and dominate the index.
Chipotle has never split its stock before
Since going public in early 2006 at $22 per share, Chipotle has never split its stock. For those investors who have held onto shares since then, the stock has generated a stunning return of more than 4,000%, significantly higher than the benchmark S&P 500's total return of roughly 380%.
Despite Brian Niccol's prior tenure at Yum! Brands from 2005 to 2018, during which the company underwent two separate stock splits in 2007 and 2016, there have been no indications from Niccol that a stock split is being considered for Chipotle.
Is Chipotle a buy ahead of a potential stock split?
Relying solely on the prospect of a stock split is typically discouraged. When assessing a stock's long-term potential, the company's financial performance holds far greater significance. Instead, potential investors should evaluate Chipotle's recent business performance and consider its valuation.
Looking at Chipotle's first half of 2023, the company generated $4.9 billion in revenue and $633 million in net income, representing a year-over-year increase of 15% and 51%, respectively. Additionally, Chipotle's balance sheet is in incredible shape, with no debt and $1.3 billion in cash and cash equivalents, meaning the company likely won't need to take on high-interest loans in the near future.
Turning our attention to Chipotle's valuation, the company has long been regarded as an expensive stock due to its high price-to-earnings (P/E) ratio -- a standard valuation metric for mature companies. As of this writing, Chipotle's stock traded at a P/E ratio of 45, which appears high compared to the S&P 500's P/E ratio of 19.
However, the valuation may not be absurdly high, considering Chipotle's five-year average P/E ratio is 80 and its plans to reach 7,000 restaurants in North America, representing a 119% increase from its current store count. Overall, if Chipotle hits management's goals for expansion, the stock may still be reasonable for long-term investors, but patience will be required.
