Two big stock splits are happening this month. Find out why one is a must-buy and the other is a potential pitfall.
Stock splits often create excitement and buzz among investors, but not all splits are alike. Some stock splits point to fantastic long-term growth stories and great investment opportunities, while others may be overvalued speculation stories that ultimately lead to disappointments.
On that note, the June 2024 stock split calendar includes two household names, and I recommend buying one but not the other right now.
The stock to buy: Chipotle
Mexican fast-food giant Chipotle Mexican Grill (CMG -1.24%) is set to undergo a 50-for-1 stock split, effective June 26, 2024. While the split will drop individual share prices from the $3,155 range to approximately $63, the true appeal lies in the company’s robust fundamentals and growth prospects.
Although Chipotle is not cheap by conventional profitability metrics — boasting a price-to-earnings (P/E) ratio of 68 and a price-to-free-cash-flow (P/FCF) ratio of 66 — its revenue-based price-to-sales (P/S) ratio of 8.6x is more palatable. This is particularly notable given the robust profit margins the company enjoys in the competitive restaurant industry.
One key factor that sets Chipotle apart is its strategy of direct ownership of its restaurants. It’s an unusual approach in today’s food service industry, where most brands prefer to manage a number of franchisee locations.
Chipotle’s more hands-on approach not only supports product quality but also fosters better employee relations, leading to higher service standards and customer satisfaction. This commitment to quality and operational efficiency drives Chipotle’s strong financial performance and market position.
The company’s ability to innovate with menu offerings, such as the successful introduction of lifestyle bowls and plant-based options, continues to attract a diverse customer base. Moreover, Chipotle’s robust digital strategy, which includes a popular app and efficient delivery services, has significantly boosted sales and customer loyalty. With a well-defined expansion plan and an unwavering focus on sustainability, Chipotle is well-positioned for long-term growth.
It’s important to note that stock splits themselves don’t inherently add value to any stock; they simply make high-priced stocks more affordable to a broader range of investors. The approval of a split can be seen as a vote of confidence in future stock gains by the board of directors, but it’s largely accounting gymnastics. Nonetheless, Chipotle looks like a buy right now for the reasons above, making the upcoming stock split an opportune moment for investors to enter or expand their position in this high-performing stock.
The stock to avoid: Nvidia
On the flip side, Nvidia (NVDA 0.75%) performed a 10-for-1 stock split over the weekend, effective on the morning of June 10. While Nvidia is a leader in the generative AI boom and has a stellar track record, the stock’s lofty valuation is cause for concern.
Nvidia’s stock trades at an extremely high 70x earnings, 37x sales, and 75x free cash flow. These multiples suggest that much of the company’s future growth potential is already priced in, leaving little room for error.
In comparison, Chipotle’s valuation ratios — while also high — are less concerning. The profit-based figures are comparable to Chipotle’s, but the Mexican restaurants manager’s price-to-sales ratio of 8.6x is considerably lower than Nvidia’s 37x. Profits come and go much faster than top-line revenues, and can be manipulated with cost controls and accounting tricks.
For example, about 31% of Nvidia’s annual operating expenses are recorded in the form of stock-based compensation right now — and that ratio is rising. Chipotle also boosts its bottom-line profits with stock-based compensation, but that’s just 14% of the company’s operating costs. Nvidia is more vulnerable to stock price fluctuations, adding uncertainty to an already highly competitive market space.
Imagine a rival like Advanced Micro Devices (AMD -4.49%) undermining Nvidia’s dominant AI systems position with power-efficient and price-competitive AI accelerator chips. The sudden presence of a strong challenger could drive down Nvidia’s lofty stock valuation, perhaps inspiring top engineering talent to find work elsewhere, and undermining Nvidia’s long-term prospects.
I have sold some of my Nvidia shares recently, reinvesting the profits in another high-growth stock with a lower valuation. By diversifying my portfolio, I’m balancing the potential growth opportunities while managing risk in an unpredictable market. With or without stock splits, Nvidia certainly looks risky at today’s prices.
Why Chipotle is the better stock-split buy in June
Nvidia’s steep valuation and high stock-based compensation expenses pose significant risks in a competitive tech landscape. At the same time, Chipotle’s robust profit margins and strategic growth initiatives make it a solid investment idea right now.
I’ll agree that Nvidia’s stock split also serves the same vote-of-confidence function as Chipotle’s, but the restaurant chain’s statement looks stronger. So if you’re looking for a stock-split stock to buy today, I’d recommend taking a closer look at Chipotle while staying away from Nvidia.
Anders Bylund has positions in Nvidia. The Motley Fool has positions in and recommends Advanced Micro Devices, Chipotle Mexican Grill, and Nvidia. The Motley Fool has a disclosure policy.