A continually rising share price is generally a good thing. However, that price can eventually get so high that individual investors can’t afford to accumulate company shares. To rectify this, companies sometimes perform stock splits, which lower the share price by proportionately increasing the number of shares on the market.
It’s a sign that a company has enjoyed prolonged success, and the lower share price often attracts investors, even though a split doesn’t change anything about the stock’s fundamental valuation or its per-share financials.
Earlier this year, Chipotle Mexican Grill (NYSE: CMG) and Williams-Sonoma (NYSE: WSM) performed respective 50-for-1 and 2-for-1 stock splits.
Ironically, neither stock has done well since splitting back over the summer. That said, one stands out as a buy, while investors are probably better off avoiding the other for now.
A management shake-up and strong growth outlook make this popular restaurant stock an obvious buy
Chipotle is a straightforward business with an eye-popping history of success. The casual dining chain sells Mexican inspired cuisine using fresh ingredients, and its popularity has fueled steady store expansion over the years. Since 2006, the stock has returned a mouth-watering 6,590%, trouncing the return of the S&P 500 index. Chipotle’s beauty lies in its simplicity. The product menu is simple, consisting of a handful of proteins and sides, served in a few form factors, such as burritos, bowls, or salads.
The company is profitable, generating $1.3 billion in free cash flow over the past four quarters, on $10.66 billion in sales. Management funds store expansion with some of Chipotle’s profits and repurchases stock with the rest, further boosting earnings growth. Chipotle’s split-adjusted share count has decreased nearly 12% over the past decade, while earnings per share have increased 262%. The great thing about Chipotle is that it still has just 3,146 stores, primarily located in the United States. It can continue opening stores and repurchasing stock for the foreseeable future.
Recently, Chipotle’s CEO Brian Niccol abruptly left the company to join Starbucks. His departure helped contribute to the stock’s lackluster post-split performance.
Market-beating stocks are seldom cheap, so it could be wise to snatch up Chipotle while it’s trading at a reasonable price. Analysts believe Chipotle will grow earnings by an average of 22% annually over the long term, making the stock’s forward P/E of 54 digestible for those planning to hold the stock for years since it can grow into its valuation.
Luxury goods aren’t in style while consumers struggle
People with money have seemingly always had a taste for the finer things. Williams-Sonoma is a specialty retailer that sells high-end home goods and furnishings. It operates store brands like Pottery Barn and has a strong e-commerce footprint. The company has been public since the 1980s and has delivered market-beating returns for decades. The stock’s lifetime total returns, between share price appreciation and dividends, exceed 42,000%. This is a company you want to keep in your portfolio.
If so, why should investors avoid the stock? Companies like Williams-Sonoma can struggle when consumers tighten up on discretionary purchases. While a $300 frying pan is probably nice to have, it’s not something most people will buy during tough times. Inflation has eaten away at consumers’ buying power over the past few years. Household savings in the United States are near multiyear lows, and credit card debt is at all-time highs. That’s not conducive to luxury purchases. Williams-Sonoma anticipates a 1.5% to 4% revenue decline in 2024 after lowering guidance in the second quarter.
Williams-Sonoma appears to be a much less expensive stock than Chipotle, at just under 18 times its estimated 2024 earnings. However, it doesn’t look like a better value. Analysts anticipate just over 6% annualized earnings growth over the next three to five years, and it’s hard to know whether that will hold if consumers continue struggling. High-earners can sometimes be resilient spenders, but Williams-Sonoma’s reduced guidance is reason to pause and exercise patience. I still like the company as a long-term stock, but economic turbulence could easily afford investors better buying opportunities in the future.
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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, Starbucks, and Williams-Sonoma. The Motley Fool recommends the following options: short December 2024 $54 puts on Chipotle Mexican Grill. The Motley Fool has a disclosure policy.
1 Stock-Split Stock to Buy Hand Over Fist in October and 1 to Avoid was originally published by The Motley Fool
