With the market in turmoil this year -- and many companies seeing their share prices hammered -- it might appear that nearly every stock out there is cheap. Some popular consumer-focused tickers in particular are selling at historically low valuations, which might entice investors to jump on board.
But don't be mistaken. There are still stocks out there that might be on the expensive side, despite the market's weak performance this year. Chipotle Mexican Grill (CMG -1.15%) comes to the top of my mind. It has been a winning investment, but it might be a good idea to think twice before you become a shareholder in this top restaurant stock.
Chipotle's business has been thriving
While many restaurant businesses struggled just to survive during the pandemic, Chipotle flourished. Leaning heavily on its digital infrastructure that lets hungry customers order for pickup or delivery, the company strengthened its competitive position in recent years. After growing 7.1% in 2020, sales surged 26.1% in 2021.
Unsurprisingly, tough comparisons have resulted in a mild slowdown, with same-store sales, or comps, increasing 10.1% in the second quarter versus 31.2% in the prior-year period. Plus, rising costs for things like beef, avocados, and labor are putting pressure on margins.
Chipotle will announce third-quarter financial results on Tuesday, Oct. 25, after the market closes. Management expects same-store sales to increase to mid- to high single-digits, which would be a sharp slowdown compared to recent quarters.
Nonetheless, the long-term outlook for the business remains as robust as ever. Management thinks that there could one day be 7,000 Chipotle locations in North America, up from 3,052 today. Furthermore, they believe each store could pull in at least $3 million in annual unit volume (AUV), up from just over $2.7 million today, with the expectation that this could move even higher over time.
That's quite a bullish outlook for a business that has already demonstrated tremendous success. Even so, don't rush to buy the stock just yet.
The stock looks expensive
As things stand today, Chipotle's stock sells for a price-to-earnings (P/E) multiple of 57. This valuation means that shares are more expensive than other popular restaurant stocks, like McDonald's, Domino's Pizza, and Starbucks. To be fair, Chipotle does have a bigger growth opportunity than these peers, but that's not enough to justify the valuation.
Even if the business can somehow manage to open 400 stores per year over the next decade to reach the 7,000 mark in North America, an annual pace that hasn't been achieved in Chipotle's history, while at the same time hitting $3 million in AUV, the stock still looks expensive. With a profit margin of 15%, up substantially from a trailing 10-year peak of 10.8%, and $21 billion in estimated company sales, this equates to $3.2 billion in profit in 2032.
I think it's reasonable to assume that Chipotle's current P/E ratio will compress as the company matures. So if we apply a multiple of 28, about half the current valuation, the business will be valued at $82 billion in 2032. Compared to the current market cap of $42 billion, this implies a double in the stock price over the next decade, or about 7% per year, hardly a robust return. And remember, this is an extremely bullish scenario where Chipotle opens more stores annually than it ever has in its entire history.
But one thing Chipotle has going for it is its powerful brand, which only got stronger over the past couple of years. This creates some additional upside to the investment situation, particularly if leadership determines that they underestimated the growth opportunity. This was the case recently, as the store target was pushed up to 7,000 from 6,000 previously. Obviously, if this number goes up again, it would make the stock look cheaper.
However, this perspective gives investors zero margin of safety, as the optimism surrounding Chipotle's prospects appears to be fully priced into the stock and then some. As a result, I think the best course of action for investors is to wait for a meaningful pullback before buying shares.
