Stock splits often serve as a catalyst for stocks. On the surface, they change nothing fundamental about a company. If one share was worth $1,000 before the split, having 10 shares at $100 per share leaves them with a holding of equal value.
Nonetheless, a split offers indirect benefits, such as making whole shares more affordable to small investors or making the act of writing covered calls less costly. Also, since the perceived need for a split is bullish, stocks often perform well after a split.
However, not all stocks that have split will keep rising, and reverse stock splits often affect a stock negatively. In 2024, splits have led to each of these scenarios, and these two examples illustrate each situation well.
Stock-split stock to buy: Chipotle
Chipotle's (NYSE: CMG) massive growth over its 18-year history culminated in a 50-for-1 stock split in January. Given its business strategy, one can see why it grew enough to necessitate that move.
The fast-casual giant has shown that a restaurant can offer healthy fast food at an affordable price. Moreover, it continues to innovate, creating a digital ordering system and combining that with Chipotlanes, enabling speedier food preparation and delivery.
The company estimated that through its growth and innovation, it could expand to 7,000 restaurants across North America, roughly double its current restaurant count of just over 3,600. More than 3,500 of those locations are in the U.S., implying massive potential for international expansion.
Unfortunately, its value proposition took an unexpected hit when CEO Brian Niccol resigned to take the CEO job at Starbucks. Niccol was the first successful CEO since founder Steve Ellis departed. Under Niccol's tenure, E. coli outbreaks at the restaurants ended, and innovations such as the Chipotlane moved forward.
COO Scott Boatwright has taken over as interim CEO, and so far, no signs of financial trouble have appeared. Its revenue of $8.5 billion for the first three quarters of 2024 rose 15% from year-ago levels, including a 13% yearly increase for the third quarter. During that time, it held operating expense growth to 13%, allowing its $1.2 billion net income to rise 27% year over year.
Chipotle stock also recovered quickly from the news of Niccol's departure, and it is up 30% so far in 2024. Moreover, the stock continues to trade at a price-to-earnings (P/E) ratio of approximately 55. While that may sound high, Chipotle has commanded such a premium for several years.
Admittedly, with an interim CEO, its leadership direction may seem uncertain. Much will also ride on future international expansion, which has not yet become a major focal point for the company. However, with former CEO Niccol leaving the company firmly positioned for continued expansion, its stock should continue to grow post-split.
Stock-split stock to avoid: Sirius XM Holdings
In contrast, reverse stock splits often point to signs of struggle, which could be the case with Sirius XM Holdings (NASDAQ: SIRI). The company announced a 1-for-10 reverse stock split following its split-off from Liberty Media.
Reverse stock splits are often a sign of financial weakness. Nonetheless, in other ways, it looks like a stock to own. The most significant sign of that may be the increased stake from Warren Buffett's Berkshire Hathaway. Berkshire has been a net seller of stock in recent quarters, yet amid the merger, Buffett's team increased its Sirius XM position. As of this writing, it now holds 32% of the outstanding shares.
Additionally, Sirius XM benefits from a legal monopoly on satellite radio in the U.S. Unfortunately, the wide availability of streamed media has rendered the satellite radio monopoly less meaningful. The shrinking subscriber numbers confirm this, and its subscriber base of 33 million in the third quarter of 2024 is down from 34 million one year ago.
With that, the revenue in the first nine months of 2024 of $6.5 billion fell over 2% from year-ago levels. A $3.4 billion impairment charge was the cause of $2.4 billion in losses in the first half of the year. Still, the concerning sign for its financials is probably the falling free cash flow. Although its forecasted free cash flow for the same nine-month period was $499 million, it still represents a considerable drop from the same period in 2023, when free cash flow was $780 million.
Indeed, its P/E ratio of 8 may have helped draw the bargain-conscious Warren Buffett into the stock. Nonetheless, Buffett's team recently took a substantial loss in Paramount Global, another struggling media stock. Unless Sirius XM can grow its subscriber base, it could turn into the same type of mistake for Berkshire Hathaway.
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Will Healy has positions in Berkshire Hathaway. The Motley Fool has positions in and recommends Berkshire Hathaway, Chipotle Mexican Grill, and Starbucks. The Motley Fool recommends the following options: short December 2024 $54 puts on Chipotle Mexican Grill. The Motley Fool has a disclosure policy.
