The Power of Earnings: Chipotle

Chartists, momentum investors and palm readers may disagree, but at The Motley Fool we know that a stock is worth only the cash flow its underlying business generates. But as investors, how do we know if we're buying those cash flows on the cheap or if we're paying too much for future expectations?

Try using the earnings power value (EPV), a quick way to calculate the value of a company's current earnings. Once we've crunched the numbers, we can then compare the EPV to a company's stock price to determine the value that investors are giving its earnings growth. Then you can make the call if it's worth paying up for that future growth.

If you're new to the EPV way, check out our primer here. Don't worry: You don't need a Ph.D. in finance -- just a few numbers you can easily find at Fool.com. Let's take a quick look at the EPV for Chipotle (NYSE: CMG  ) .

First: What it does
Chipotle operates a national chain of fast-casual restaurants with a focused menu of burritos, tacos, burrito bowls (a burrito without the tortilla) and salads. Chipotle opened its first restaurant in 1993 and currently operates more than 1,000 restaurants.

Second: The value of today's earnings
Using our handy EPV primer from above and a 10% discount rate, we get the following for Chipotle:

EPV Cash Flow (TTM)

Current Earnings Value Per Share

Current Stock Price

Value of Growth Per Share

% Growth Implied in Stock Price

$194 million

$69.20

$151.60

$82.40

54%

TTM = Trailing 12 months.

Third: Is it worth it?
I'm not surprised to see that growth accounts for more than half of Chipotle's stock price. Chipotle has had a fantastic run and continues to post enviable operating results. Over the last 5 years, for example, Chipotle has grown revenue at a 24% annual clip. Even more impressive is its 5 year annual growth rate in earnings of about 59%. At a current base of 1,000 stores, Chipotle has plenty of room to grow, potentially tripling the number of domestic restaurants in the coming years. There's also the potential for international expansion, which could be significant. Analysts expect 29% earnings growth this year and 19% growth next year.

Fourth: Chipotle's EPV vs. 3 Competitors
Let's see how Chipotle stacks up against three other companies playing in the restaurant space. Running these three companies through our EPV calculator gets us:

Company

Current Earnings Value Per Share

Current Stock Price

Value of Growth Per Share

% Growth Implied in Stock Price

McDonald's
(NYSE: MCD  )

$43.80

$71.74

$27.97

39%

Yum! Brands
(NYSE: YUM  )

$30.05

$42.36

$12.29

29%

Darden Restaurants (NYSE: DRI  )

$36.25

$41.82

$5.56

13%

Interestingly, Chipotle's current stock price has more growth built into it than these 3 other restaurant companies. That's not surprising considering the rocket ride that Chipotle's shares have enjoyed. We discussed above the potential for Chipotle to grow, and so we'd also benefit from spending some time looking at the competition's growth prospects. Remember, EPV is a handy tool to see what price investors are putting on a company's future. But it's just a starting point.

Does Chipotle's future growth potential justify its stock price? Let us know your opinion by posting down below.

At the time of publication, Ron Gross owned shares of Chipotle. Ron is advisor of the Motley Fool Million Dollar Portfolio. Chipotle is a Motley Fool Rule Breakers choice. Chipotle is a Motley Fool Hidden Gems recommendation. Motley Fool Options has recommended a bull call spread position on Yum! Brands. The Fool owns shares of Chipotle. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 16, 2010, at 12:29 PM, penboy wrote:

    Using PVGO = P(Growth) - P(No growth) = [D1/(r-g)] - E/r to get the implied growth, the growth cannot be higher than the ROR. In this case the implied growth is around 6.8% (perpetual).

    Using a two stage model, 5 years of 25% and 2.5% forward, the fair value is $153. Since we are talking cheapness here, Chipotle has a relatively high bar to cross to justify the current price.

    But the market is not predictable nor reasonable, as a case in point, VMW is trading at $84 on $4.8 of revenue and 60c of earnings per share.

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