Stock splits occur when companies divide their shares into multiple lower-priced units without changing their market caps, which is the value of all the shares combined .
Think of it like a pizza. Whether the pieces are small or large, the size of the pie remains the same, but it can be divided into as many slices as you want. This tactic can be a great way to make an expensive stock more liquid and attractive to smaller investors with less cash available.
After enjoying explosive rallies over the last five years, Nvidia (NASDAQ: NVDA) and Chipotle Mexican Grill (NYSE: CMG) have decided to split their stocks. Let's explore what this could mean for long-term investors of these two stocks.
1. Nvidia
With shares up by a nosebleed-inducing 2,800% in just five years, Nvidia has a lot of incentive to keep its stock price more accessible for investors who don't have thousands of dollars lying around.
On May 22, the technology giant announced a 10-for-1 stock split, which will go into effect on June 10. The soon-to-be lower stock price could boost Nvidia's liquidity and help investors overcome the psychological barrier to buying a company currently trading for four figures. Meanwhile, Nvidia's fundamentals remain excellent. And it dominates the market for advanced generative artificial intelligence (AI) chips.
First-quarter revenue soared 262% year over year to $26 billion, driven by sales of graphics processing units (GPU) like the H100 and H200 to data center clients. The company plans to cement its lead over rivals by speeding up its chip upgrade cycle from every two years to every year. The new chips could enjoy robust demand because they make training AI models faster and more energy efficient.
Image source: Getty Images.
Despite its high price tag, Nvidia stock is still relatively affordable from a valuation perspective. With a forward price-to-earnings (P/E) multiple of 41, it's cheaper than rival chipmaker Advanced Micro Devices, which is valued at 47 times forward earnings despite a revenue growth rate of just 2% in its most recent quarter. (Remember, Nvidia grew sales by 262%.)
2. Chipotle Mexican Grill
While tech companies are typically known for breakneck growth rates, sometimes restaurants can also soar by tackling an old industry in an exciting new way. With shares up 376% over the last five years (to around $3,151), the Mexican-inspired fast-casual chain Chipotle has become a victim of its own success. Management thinks a lower stock price could be beneficial to its long-term goals.
Chipotle's massive 50-for-1 stock split, which goes into effect on June 18, will dramatically lower its stock price and make it more liquid for smaller retail investors who might not have access to fractional shares . More importantly, the split may help the company improve its operational performance by allowing it to reward top-performing managers with more specific increments of stock, which is hard to do with the high price tag.
The goal is to improve throughput (a metric that measures how fast customers move through the line) by having a more skilled and motivated workforce with a sense of ownership in the company .
Chipotle is also on the cusp of a major international expansion that will bring its unique fast-casual Mexican concept to new markets like Europe and the Middle East. In April, the company opened its first restaurant in Kuwait and plans to open several Dubai locations this year.
Focus on the fundamentals
Stock splits are generally a bullish signal because they usually follow sustained stock-price appreciation. That said, investors shouldn't lose sight of fundamentals. With its rapid growth rate and low valuation, Nvidia remains one of the most attractive stocks on the market right now. Chipotle is also a great pick because of its strong brand and international expansion potential.
Will Ebiefung has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill and Nvidia. The Motley Fool has a disclosure policy .
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