The stock market has had a meteoric start to the year in 2024. S&P500 rose 11% and positive investor enthusiasm shows no signs of slowing down.
What I find encouraging is that these strong returns are spread across many different sectors. One company that performs particularly well is the restaurant chain Chipotle Mexican Grill (NYSE:CMG).
Chipotle is a major holding of hedge fund manager Bill Ackman, CEO of Pershing Square Capital Management. In March, Chipotle’s board approved a 50-for-1 stock split. Importantly, shareholders must still approve the split at the company’s annual meeting on June 6.
Let’s take a look at the ins and outs of stock splits and evaluate whether you should acquire Chipotle stock now.
Why is Chipotle splitting its shares?
Stock splits are an interesting concept. A common misconception about stock splits is that the stock becomes less expensive after the split takes effect. In reality, this is not the case.
When a stock split occurs, a company increases its outstanding shares by the ratio of the split. In Chipotle’s case, current shareholders would receive 50 shares for each share they own.
As the number of shares outstanding increases, the stock price decreases by the same multiple. Given this dynamic, stock splits do not in themselves change the company’s market capitalization.
For Chipotle, there are several obvious reasons why management is considering a stock split. In 2018, Chipotle experienced some operational difficulties. The company named Brian Niccol as CEO in hopes the food industry veteran can lead a turnaround. Since Niccol took over as CEO in March 2018, Chipotle stock is up 926%.
Today, shares are trading at around $3,200. This puts the stock out of reach for most retail investors. During Chipotle’s first-quarter earnings call, management talked about the proposed stock split, saying it would “make our shares more accessible to our employees, as well as a broader range of investors.” .
Again, even if the split doesn’t actually change Chipotle’s value, the falling stock price causes investors to perceive the shares as more affordable and thus tends to stimulate new buying activity.
How is Chipotle performing?
It’s no secret that the macroeconomy has been facing a tough battle against inflation for almost two years. Indeed, while inflation has calmed down to 3.4%, prices remain high in certain areas and weigh on consumers.
Specifically, food and grocery prices have been particularly stubborn. Given that Chipotle is a fast-casual restaurant and, ultimately, a consumer discretionary type of purchase, you might think the company is in trouble right now.
However, the charts below illustrate a very different story. Not only are Chipotle’s sales skyrocketing, but operating margins are also growing at an impressive rate.
There are several reasons. First, Chipotle is investing heavily in digital operations. In today’s world, people are increasingly opting for digital platforms for almost every product or service.
In the first quarter, digital sales accounted for more than a third of Chipotle’s revenue. And at the end of the first quarter, Chipotle had nearly 40 million rewarded members that it can reach through its app.
Introducing technology into the labor-intensive restaurant environment can lead to more automation and improve efficiency and order fulfillment. If executed correctly, these investments pay off in the form of repeat purchases and engaged customers.
This has helped Chipotle build incredibly strong brand equity while gaining enviable pricing power over the competition. This translates into loyal customers, as evidenced by the company’s financial results.
For the quarter ended March 31, Chipotle’s same-store sales increased 7% year over year. In comparison, sales comparable to McDonalds grew by only 2% year-on-year in the first quarter.
Is Chipotle a good stock to buy right now?
One downside to Chipotle stock is its valuation. With a price-to-earnings (P/E) ratio of 68, Chipotle stock is expensive. However, I believe the company has earned its premium valuation and still presents an attractive investment opportunity for long-term investors.
Remember, if the stock split is approved by shareholders and goes into effect in June, there’s a good chance there will be some momentum between Chipotle and shares could soar. Although this is the case look as if you bought Chipotle stock at a lower price, you would actually pay an even higher valuation.
Given the company’s success in growing in an otherwise volatile economy, coupled with its innovation efforts, I see even better days ahead for Chipotle. I believe investments in a digital platform will ultimately deliver significant margin expansion and long-term cash flow generation, providing Chipotle with strong and sustainable financial flexibility.
Despite a high price, I think it’s a good time to grab some shares before the split.
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Adam Spatacco has no position in any of the stocks mentioned. The Motley Fool posts and recommends Chipotle Mexican Grill. The Motley Fool has a disclosure policy.
Up 926%, Is This Sizzling Bill Ackman Stock a Buy Before Its 50-for-1 Split? was originally published by The Motley Fool