Over the past 30 years, investors have almost always had a new innovation or trend to latch onto. Cutting-edge technologies like the Internet, genome decoding, 3D printing, blockchain technology, and the metaverse represent some of the examples of potentially revolutionary trends for American businesses.
Right now, investors are focusing on two hot trends. Although you are probably familiar with the rise of artificial intelligence (AI)You may not know how popular splitting stocks have become.
A stock split is an event that allows a publicly traded company to change the number of shares outstanding and its stock price by the same magnitude without impacting its market capitalization or operating performance. Splits come in two forms: forward and backward.
With a forward stock split, a company lowers its stock price to make it more affordable for retail investors and perhaps its employees. Conversely, the purpose of a reverse stock split is to increase a company’s stock price, usually to ensure that it meets minimum standards for listing on a major exchange.
Most investors focus on the former. Indeed, companies that do forward stock splits often own high-flying stocks that are a direct result of superior innovation and execution than their peers. Since the beginning of 2024, eight leading companies have announced or carried out forward stock splits.
According to a study by Bank of America According to Global Research, companies conducting forward stock splits have experienced an average return of 25.4% (since 1980) in the 12 months following their split announcement. This compares to a 12-month return of 11.9% for the benchmark index. S&P500 on the same timeline.
Despite this promising long-term data, not all split stocks are worth buying. There are two “Class of 2024” split stocks that I wouldn’t touch with a 10-foot pole.
Nvidia
Even though I ended June 18 as the largest publicly traded company in the world, I want absolutely nothing to do with the leader in AI. Nvidia (NASDAQ:NVDA). Nvidia announced a 10-for-1 stock split on May 22, which was completed after the closing bell on June 7.
Nvidia shares are up more than 800% since the start of 2023 – an increase of almost $3 trillion in market value – because its graphics processing units (GPUs) have quickly become the standard in computing centers. data accelerated by AI. Semiconductor analytics firm TechInsights recently noted that Nvidia accounted for 98% of the 3.85 million AI GPUs shipped in 2023.
The seemingly insatiable demand for GPU AI has also worked in Nvidia’s favor. The laws of economics state that if demand for a good or service exceeds supply, the price of that good or service will increase until demand decreases. Nvidia was able to substantially raise the price of its prized H100 GPUs, which pushed its adjusted gross margin to 78.4% in the fiscal first quarter (ended April 28).
While there are plenty of reasons for Nvidia shareholders to be grateful, there are also plenty of warnings that Wall Street’s hottest split stock is in a bubble.
For starters, we haven’t seen a large-scale investment in at least 30 years that has avoided a potential bubble burst. No matter how promising a technology, innovation or trend is, investors always overestimate the adoption of anything that creates buzz on Wall Street. With no company helped more by the rise of AI than Nvidia, an AI bubble burst event would likely hurt its stock the most.
I think it’s fair to say that competition is also an issue. While optimists are quick to point out that Nvidia’s GPUs have a compute advantage over other AI GPUs, the issue is more about numbers than a performance concern. Nvidia can’t fulfill all of its orders, which opens the door for external competitors to steal share.
As I have already pointed out, this competition is also internal. Nvidia’s four largest customers, representing approximately 40% of its net revenue, are members of the “Magnificent Seven.” The problem is that these four Magnificent Seven constituents are developing AI GPUs for their own data centers. Even if these chips are used only as a complement to Nvidia’s H100 GPU, this suggests that we are seeing a spike in reliance on Nvidia’s data center hardware.
The valuation is also quite terrifying. Although Nvidia is not ridiculously expensive, based on its price-to-earnings-growth ratio (PEG ratio), the company’s 12-month price-to-sales ratio of 42 is equivalent to peak levels seen with Cisco Systems And Amazon before the bursting of the Internet bubble. If history rhymes, Nvidia stock could ultimately plunge by more than 50%.
Chipotle Mexican Grill
The second split stock I wouldn’t touch with a 10-foot pole right now is none other than a fast-casual restaurant chain. Chipotle Mexican Grill (NYSE:CMG). Chipotle’s board of directors announced a 50-to-1 forward split on March 19, which was approved by shareholders at the company’s annual meeting earlier this month. This mammoth stock split will go into effect after the closing bell on Tuesday, June 25.
Just because I don’t want anything to do with Chipotle doesn’t mean the company hasn’t performed well from an operational standpoint. The company’s management team has long understood that consumers will pay more for better quality food. That’s why Chipotle aims to source vegetables locally, when possible, and only uses responsibly raised meats.
Chipotle’s limited menu also explains its long-term success. By intentionally keeping its menu small, the company ensures that food preparation is efficient and guests are served quickly. Plus, new food innovations become more pop with such a small menu.
But at some point, the company’s valuation no longer makes sense – and we’ve certainly reached that point, in my opinion.
After a nearly 15,500% increase in its shares since its $22 IPO price in January 2006, Chipotle trades at 62 times forecast 2024 earnings and 51 times earnings for the coming year . Even though Wall Street projects an annualized earnings growth rate of 22% through 2028, things don’t make sense.
While Chipotle’s mid-teens sales growth probably seems impressive given the company’s already large size, its revenue growth isn’t as dramatic if you dig a little deeper. Comparable restaurant sales in the first quarter increased 7%, with new store openings accounting for the rest of the growth. This 7% same-store growth results from a 5.4% increase in transactions and a 1.6% increase in check amounts.
While 7% same-store sales growth is impressive in the fast-casual restaurant sector, it does not justify a forward price-to-earnings ratio of 51, especially when part of that increase is the result of inflation that pushes prices up.
I will also add that there is only so much innovation Chipotle can squeeze out of its business. The addition of mobile ordering drive-thru lanes (“Chipotlanes”), as well as the introduction of the occasional new menu item, has shaken things up – but not enough to command such a valuation premium.
I’ll be looking for Chipotle Mexican Grill stock to pull back significantly once the stock split euphoria wears off.
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Bank of America is an advertising partner of The Ascent, a Motley Fool company. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Sean Williams has positions in Amazon and Bank of America. The Motley Fool holds positions and recommends Amazon, Bank of America, Chipotle Mexican Grill, Cisco Systems and Nvidia. The Motley Fool has a disclosure policy.
2 Split Actions I Wouldn’t Touch With a 10 Foot Pole was originally published by The Motley Fool
