Chipotle Has 1 of the Biggest Stock Splits in New York Stock Exchange History. Here's Why I'm Still Not Buying It.
Fast food chain Chipotle Mexican Grill (NYSE: CMG) recently announced one of the largest stock splits in the New York Stock Exchange's history. The company's shares will be sliced up 50-to-1, resetting the stock's share price to roughly $57 per share. The split will go into effect in a few months.
By some measures, the stock split is already a smashing success. Chipotle's stock has been up since the announcement. However, I'm standing happily on the sidelines. Here is why I'm not buying Chipotle's monumental stock split.
Understanding what stock splits do
Investors love stock splits, and company employees love stock splits. Why is that? Well, it's for different reasons. A stock split lowers a stock's share price by proportionately increasing the number of outstanding shares. In other words, Chipotle's current share price of $2,880 will be divided by 50, and the quantity of shares will increase 50-fold.
Ultimately, it's all about liquidity. Investors like lower share prices because they make it easier to accumulate shares of the stock. Employees like lower share prices because they make selling the equity they've acquired working for the company easier. A Chipotle employee might not want to sell their equity in nearly $3,000 chunks.
Importantly, the split doesn't impact the company's fundamental valuation. Earnings and other per-share financials are split, too. If you cut a cake once for two people and again for four, everyone gets a smaller piece. No matter how many times you cut it up, the cake stays the same size.
A spicy stock, no matter how you slice it
It's not that Chipotle isn't a good investment. The stock has outperformed the broader market since going public. My problem lies with how much Wall Street demands investors pay to own shares. Today, Chipotle trades at a forward P/E of 54.
That's a high valuation. Interestingly, though, Chipotle's growth outlook is nearly as impressive. Analysts believe earnings will compound at 20% over the long term as the company opens new stores and repurchases shares. Repurchases have retired nearly 12% of shares over the past decade.
There are still just 3,437 Chipotle locations today, compared to nearly 8,000 Taco Bell locations in America. Considering Chipotle started in 1993, that growth formula could go on for many years without running out of runway.
This combination of store expansion and steady share repurchases puts a solid floor under Chipotle's long-term earnings growth. Unless people suddenly hate Chipotle, there's a good chance the company's making more profits five years, 10 years, or 25 years from now.
But 54 times earnings is too expensive, even for such durable growth. I like using the PEG ratio to double-check my logic before buying stocks. It shows you how much you pay for the company's earnings growth. I look for a PEG ratio under 1.5, and Chipotle's is 2.7, which is almost double. So it's not that Chipotle is a tad expensive -- it's unreasonably expensive.
What price should investors stomach?
Remember, a company can be amazing, but the stock won't be if you dramatically overpay to own it. Over time, expensive stocks almost always revert to a more appropriate valuation. The share price either falls or stagnates while earnings grow and catch up. Chipotle will probably do the same thing in the future. Be patient and consider waiting for a better buying opportunity.
Predicting a stock's short-term performance is impossible, but investors can set up hypothetical price ranges at which buying would make more sense. For Chipotle, the stock would need to grow earnings by 20% annually and trade at 30 times earnings to generate that 1.5 PEG ratio I am looking for now.
Analysts expect Chipotle to earn $53 per share this year, making the stock a buy at 30 times those earnings, or $1,590 or less.
Should you invest $1,000 in Chipotle Mexican Grill right now?
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Justin Pope has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill. The Motley Fool has a disclosure policy.
Chipotle Has 1 of the Biggest Stock Splits in New York Stock Exchange History. Here's Why I'm Still Not Buying It. was originally published by The Motley Fool
