It's a story that has been told for years now. Investors don't want to get involved with Chipotle Mexican Grill (NYSE:CMG) because it's too expensive. While Chipotle is expensive at 54 times earnings, most people who make this statement are referring to the stock price, which should be ignored. If a stock price is higher, it will often move many more points in a day than the average-priced stock. Therefore, you should be paying more attention to valuation and the underlying business.
In Chipotle's case, the expectations are high, but the underlying business is exceptional. Not only is Chipotle outperforming other fast-casual and fast-food restaurants, it has now added a menu item that should only increase its potential.
Invasion of the Sofritas
Last year, this tofu filling began as a test in the San Francisco Bay area, and many people scoffed at the idea. However, it has been so successful that Chipotle plans on adding it to all of its locations by the end of 2014.
In the restaurants where Sofritas are offered, the filling averages 3% of sales. This might not sound like a lot, but it's still early. The irony here is that approximately 50% of customers who opt for Sofritas are meat-eaters who are just looking for a change. Another irony is that the filling was developed by ShopHouse Southeast Asian Kitchen, which, by the way, is owned by Chipotle.
Key to success
Do you know when Chipotle last added a permanent menu item? If you guessed 2005, you're correct. Chipotle added salads in 2005. However, the point here isn't to test your knowledge of Chipotle history, it's to show that Chipotle is unlike many other restaurants, such as McDonald's (NYSE:MCD) and Wendy's (NASDAQ:WEN), that constantly offer limited-time menu items in order to increase their foot traffic.
If you want the simple version, Chipotle doesn't need to use limited-time menu offerings in order to increase its foot traffic. For example, look at the enormous difference in top-line growth among these three companies over the past five years:
Yes, these three companies compete with one another. Chipotle is a favorite destination for millennials, and McDonald's and Wendy's are consistently trying to attract that market -- especially McDonald's.
By not offering limited-time menu items, Chipotle spends less on advertising and employee training. Instead, it remains focused on high-quality and high-demand menu items.
Wendy's and McDonald's have had different results with their limited-time menu offerings. Wendy's had a hit with its Pretzel Bacon Cheeseburger, and McDonald's didn't meet its own expectations with its Mighty Wings.
If a future limited-time offering doesn't succeed, then the company will have wasted millions of dollars on advertising. This is a potential negative for McDonald's and Wendy's. For instance, McDonald's did not sell enough Mighty Wings and ended up with 10 million pounds of them, so it is now offering five Mighty Wings for $3 in an effort to clear its inventory.
Wendy's has been more successful with its limited-time offerings, and thanks to its Image Activation program -- modernization of restaurants -- its potential is high. However, as long as it takes the limited-time offering approach, there will be risks. Once again, not all of the limited-time menu offerings will be hits. Chipotle doesn't have to worry about this because it sees high demand for the products on its simple menu.
Additionally, while Chipotle is expensive at 54 times earnings, Wendy's is trading at a whopping 88 times earnings. Wendy's can meet these expectations, but the risks are high. As far as McDonald's goes, it's trading at just 17 times earnings. Therefore, if you're looking for safety and a generous dividend yield of 3.40%, then you might want to dig deeper on McDonald's.
The Foolish takeaway
While fast-food (or quick-service) restaurants like McDonald's and Wendy's battle for customers by using limited-time offerings, Chipotle sits back and watches hordes of customers walk through its doors who seek items on its simple menu. Not only is this a positive for the top line, it results in fewer expenses. Put simply, Chipotle is hot. As always, please do your own research prior to making any investment decisions.
Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill and McDonald's. The Motley Fool owns shares of Chipotle Mexican Grill and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.