Tissue homeostasis involves a complex balance of developmental signals and environmental cues that dictate stem cell function. We found that dietary lipids control enteroendocrine cell production from Drosophila posterior midgut stem cells. Dietary cholesterol influences new intestinal cell differentiation in an Hr96-dependent manner by altering the level and duration of Notch signaling. Exogenous lipids modulate Delta ligand and Notch extracellular domain stability and alter their trafficking in endosomal vesicles. Lipid-modulated Notch signaling occurs in other nutrient-dependent tissues, suggesting that Delta trafficking in many cells is sensitive to cellular sterol levels. These diet-mediated alterations in young animals contribute to a metabolic program that persists after the diet changes. A low-sterol diet also slows the proliferation of enteroendocrine tumors initiated by Notch pathway disruption. Thus, a specific dietary nutrient can modify a key intercellular signaling pathway to shift stem cell differentiation and cause lasting changes in tissue structure and physiology.