Perhaps no other topic has been on every investor's mind more in the last year than inflation. Based on the widely followed Consumer Price Index (CPI), inflation is at levels we haven't seen in decades. And this has forced the Federal Reserve to aggressively hike interest rates to stabilize prices.
Consequently, the investing community is looking at ways to bolster their portfolios in this type of situation. For those who are worried about the threat of rising prices across the economy, it might be a good idea to take a closer look at Chipotle Mexican Grill (CMG 1.07%). Here's why.
A clear sign of a great business
Warren Buffett, who many consider to be the greatest investor ever, believes that the true mark of a company's quality is its ability to raise prices without any major adverse impact on customer demand. "If you've got the power to raise prices without losing business to a competitor, you've got a very good business," he said.
This makes total sense as a business that can extract more value from customers is offering a differentiated product or service that is difficult or impossible for rivals to imitate. And the result can be a stronger brand, better financials and growth, and a higher stock price.
Turning our attention to Chipotle, it's clear that this company possesses the very favorable characteristic of pricing power. In October of last year, the business raised menu prices for the fourth time in 17 months. And during the most recent quarter, menu prices were 13.5% higher year over year. This was an obvious course of action given that throughout 2022, management called out higher costs for labor, as well as key inputs like dairy, packaging, and avocados.
But Chipotle's customers continue to flock to restaurants. "We really have not seen any meaningful resistance to our pricing," CEO Brian Niccol mentioned on the fourth-quarter 2022 earnings call. A recent survey conducted by BTIG, a capital markets firm, found that only 7% of respondents said Chipotle's prices were unreasonable. What's more, customer traffic was up in January versus the prior-year period. This clearly highlights the compelling customer value proposition.
Chipotle's continued momentum demonstrates a business that is navigating the current economic situation extremely well, warranting a closer look from investors.
Giving investors pause
While Chipotle has clearly demonstrated its ability to handle inflationary pressures by successfully implementing various price hikes, a key trait that should put it on investors' radars, there is one metric that should lead to some hesitation before the stock gets added to portfolios. And that's the topic of valuation.
As of this writing, Chipotle shares are trading hands at a price-to-earnings (P/E) ratio of 49. This is far lower than the stock's trailing five- and 10-year valuation multiples, which are distorted thanks to depressed diluted earnings-per-share (EPS) figures in the second half of 2020. And it's lower than the P/E of roughly 65 from five months ago. This might cause investors to rush to buy the stock.
However, I think the current price provides a minimal margin of safety as it fully reflects the optimism surrounding the stock and business. Over the past five years, Chipotle shares have skyrocketed nearly 400%, easily crushing the S&P 500 during the same time. And this stellar performance was a direct result of new store openings and rising revenue, same-store sales, and earnings. What's more, it now appears that Chipotle's business was strengthened by the COVID-19 pandemic as its value proposition and digital prowess were able to attract customers.
Investors are fully aware of just how wonderful of an enterprise this is. The pricing power is certainly there to navigate the current macro environment, but it's best to put this on your watch list for now.
