Chipotle Mexican Grill (CMG 0.39%) is one of the most recognized restaurant chains in the world. Its relentless focus on food quality and top-notch customer service has helped it build one of the most loyal followings among fast-food businesses.
With sizzling carne asada, tasty burritos, and fresh avocado, it's hard not to enjoy a meal at Chipotle. However, the company has something new brewing, and it has nothing to do with food.
Chipotle's board of directors recently approved a 50-for-1 stock split. Assuming that the company's shareholders add their approval on June 6, split-adjusted shares will hit the exchanges later this month.
Let's dive into the mechanics of stock splits, and assess if Chipotle stock is a buy right now.
Why is Chipotle splitting its stock?
At of the time of this writing, shares of Chipotle are trading for approximately $3,063. Its all-time high stock price was about $3,200.
Broadly speaking, when a stock begins to hover around record levels, buying activity can sometimes slow down. This is because investors perceive the stock as expensive and begin looking for alternatives.
This behavior is based more in psychology than on the investing fundamentals, though. When a company undergoes a stock split, the number of outstanding shares rises by the stated ratio. At the same time, the share price is reduced by that same ratio -- therefore, the market cap and valuations of the company remain unchanged.
Nevertheless, Chipotle's management believes that splitting its stock will make it more accessible and appealing to employees and retail investors.
Image source: Getty Images.
Chipotle is a best-in-breed business
I wouldn't be surprised if you have some trepidation when it comes to investing in a restaurant stock. Macroeconomic factors such as inflation and higher interest rates have taken a toll on consumer discretionary spending. As such, a business that depends on people's willingness to pay for small indulgences like take-out meals may not come across as the most enticing investment opportunity.
Chipotle has differentiated itself from some of its peers through investments in technology. The company makes venture capital-style investments in all areas across the food spectrum -- from sourcing ingredients to sustainability and more. These investments have helped it innovate its menu offerings, build out a digital app, and understand customer dynamics on a deeper level. As a result, the company is generating transformational growth in both revenue and profits.
Yet while all of this is encouraging, there is one more variable it's important to unpack before making a decision about whether or not to buy shares of Chipotle.
Should you invest in Chipotle stock before the split?
When a stock split is on the horizon, the question of whether to buy shares before or after it takes place is a common conundrum for investors. Often, share prices rise following a split as more investors pour in and scoop up shares at a perceived lower cost.
However, the lower price tag on the stock does not mean that you're actually buying in at a lower valuation. In fact, when momentum traders begin acquiring the stock and shares sharply rise, the market cap increases as well -- meaning that you're actually investing at a higher price point than was available before the split.
CMG PE Ratio data by YCharts.
This chart illustrates Chipotle's price-to-earnings (P/E) ratio over the last five years. Although its P/E has normalized from its highs of a few years ago, Chipotle stock has historically been pretty pricey compared to the broader market.
That said, its long-term shareholders have been handsomely rewarded. Over the last five years, Chipotle has delivered a total return of 362%. By contrast, the Vanguard S&P 500 ETF had a total return of 107%. Zooming out further, over the past 10 years, Chipotle stock has returned 453% compared to the Vanguard S&P 500 ETF's return of 228%.
All things considered, Chipotle has been a terrific investment, and I suspect that dynamic will continue after the split later this month. Given its superior returns compared to funds that track the S&P 500, I'd say that Chipotle's premium valuation is warranted.
I think the prudent strategy would be to scoop up shares of Chipotle before the split. However, in the grand scheme of things, it's not that important when exactly you buy this stock. Your investment thesis should be rooted in the fundamentals of the business as well as a conviction that Chipotle can fend off competition.
