The stock market has gotten off to a red-hot start in 2024. The S&P 500 has risen 11%, and positive investor enthusiasm doesn't appear to be slowing down.
What I find encouraging is that these strong returns are spread out across many different sectors. One company that is performing particularly well is restaurant chain Chipotle Mexican Grill (CMG 0.20%).
Chipotle is a prominent holding of hedge fund manager Bill Ackman, the CEO of Pershing Square Capital Management. In March, Chipotle's Board of Directors approved a 50-for-1 stock split. Importantly, shareholders still need to approve the split at the company's annual meeting on June 6.
Let's dive into the ins and outs of stock splits, and assess whether you should scoop up shares of Chipotle right now.
Why is Chipotle splitting its stock?
Stock splits are an interesting concept. A common misconception about stock splits is that the stock becomes cheaper after the split goes into effect. In reality, this is not the case.
When a stock split occurs, a company increases its outstanding shares by the ratio in the split. In the case of Chipotle, current shareholders would receive 50 shares for every one share that they own.
Since the number of outstanding shares rises, the stock price is lowered by the same multiple. Given this dynamic, stock splits do not inherently change the market capitalization of the company.
For Chipotle, there are a couple of obvious reasons why management is pursuing a stock split. In 2018, Chipotle was experiencing some operational challenges. The company appointed Brian Niccol as its chief executive officer in hopes that the food industry veteran could lead a turnaround. Since Niccol assumed the CEO position in March 2018, Chipotle stock has risen 926%.
Today, the shares trade for roughly $3,200. This puts the stock handily out of reach for most retail investors. During Chipotle's first-quarter earnings call, management spoke about the proposed stock split, stating that it "will make our stock more accessible to our employees, as well as a broader range of investors."
Again, while the split doesn't actually change the value of Chipotle, the lower stock price causes investors to perceive shares as more affordable and thereby tends to spur some new buying activity.
Image source: Getty Images.
How is Chipotle performing?
It's no secret that the macroeconomy has been facing a tough battle with inflation for almost two years now. Indeed, while inflation has cooled to 3.4%, prices remain elevated in certain areas and are weighing on the consumer.
Specifically, food and grocery prices have been particularly stubborn. Since Chipotle is a fast-casual restaurant and ultimately a consumer discretionary type of purchase, you might think the business is struggling right now.
However, the charts below illustrate a vastly different story. Not only are sales of Chipotle soaring, but operating margins are also expanding at an impressive rate.
CMG Revenue (Quarterly) data by YCharts
There are a couple of reasons. First, Chipotle is investing heavily in digital operations. People are increasingly opting for digital platforms in just about every product or service in today's world.
During the first quarter, digital sales represented more than one-third of Chipotle's revenue. And at the end of the first quarter, Chipotle boasted nearly 40 million rewards members that it can reach through its app.
Bringing technology into the labor-intensive restaurant environment can result in more automation and enhanced order efficiency and fulfillment. If executed properly, these investments pay off in the form of repeat purchases and engaged customers.
This has helped Chipotle build incredibly strong brand equity while also achieving enviable pricing power over the competition. This translates into repeat customers, which can be seen in the company's financials.
For the quarter ended March 31, Chipotle's same-store sales increased 7% year over year. By comparison, comparable sales at McDonald's only rose 2% year over year in the first quarter.
Is Chipotle a good stock to buy right now?
One drawback of Chipotle stock is valuation. With a price-to-earnings (P/E) ratio of 68, shares of Chipotle are pricey. However, I think the company has earned its premium valuation and still presents a compelling investment opportunity for long-term investors.
Remember, should the stock split be approved by shareholders and go into effect in June, there is a good chance that some momentum will enter Chipotle and shares could surge. While it will look like you're buying Chipotle stock at a lower share price, you'd actually be paying an even higher valuation.
Considering the company has managed to grow in an otherwise volatile economy, coupled with its innovation efforts, I see even better days ahead for Chipotle. I think the investments in a digital platform will ultimately generate significant margin expansion and cash flow generation in the long run -- providing Chipotle with robust, sustainable financial flexibility.
Despite a hefty price tag, I think now is a good time to scoop up some shares before the split.
