I've heard a famous finance personality refer to eating beans and rice during tough times; the fast-casual restaurant chain Chipotle Mexican Grill (CMG -0.17%) has built an empire on beans and rice. Today, the stock has a market value of $44 billion, and share prices are up 16% over the past three months as investors flock to safety in a market that can't seem to keep any momentum for very long.
Analysts believe burritos and delicious guacamole (speaking from experience) can drive tremendous earnings growth over the coming years, but the stock's spicy valuation could pose a potential problem.
Short and long-term investors could have different strategies for this popular restaurant stock; here is what you need to know.
Chipotle stock isn't as cheap as it looks
Sometimes simple business models can deliver the best business outcomes; Chipotle became a U.S. sensation by selling burritos and other Mexican-style fast foods. There's nothing earth-shattering or proprietary about what it does, and yet the company produces. The stock's grown at an impressive clip over the years, and the company's proven pricing power has investors flocking to shares.
Despite the stock's 16% rise over the past few months, its valuation remains below its long-term average. Shares averaged a price-to-earnings (P/E) ratio of 82 over the past five years but are at a P/E of 51 today:
CMG Revenue (Annual YoY Growth) data by YCharts.
That seems like a solid deal, but growth is slowing, too, so you need to consider that. Chipotle grew its earnings-per-share (EPS) by an average of 41% annually over the past five years, but analysts expect annual EPS growth to average 26% over the next three to five years. That solid deceleration makes the stock more expensive than it looks against historical averages.
So what might happen?
Chipotle should keep growing earnings, eating into the stock's valuation over time. Hypothetically, you can project out future earnings using the 26% average growth analysts call for.
Analysts believe the company will earn $41.38 per share this year. Moving forward, earnings might look something like this:
| Year | Earnings per share ($) |
|---|---|
| 2024 | 52.13 |
| 2025 | 65.69 |
| 2026 | 82.77 |
| 2027 | 104.29 |
Table by author.
It's not an exact science; a recession could crimp consumer spending and pressure Chipotle's pricing power. The company could also outperform analyst estimates, though it has a spotty track record of doing that. Chipotle beat analysts' annual EPS estimates eight times since 2007 and missed the other eight.
Averaging 26% earnings growth would mean investors get 26% annual investment returns if the stock's valuation stays the same. That's possible, given the stock is already below its long-term average (again, that seems fair given the expectation of slower earnings growth).
Investors can work in a margin of safety too; for example, suppose that Chipotle earns $104.29 per share in 2027 but trades at a P/E of just 25 -- a 50% decline in the stock's valuation. The share price at a 25 P/E would be $2,607, a 60% total price return, and an annual rate of roughly 10%.
Is Chipotle a buy today?
Whether the stock is attractive today depends on your expectations for the business moving forward and your desired investment returns. In our example, I've assumed that Chipotle hits analyst estimates, and the stock's valuation falls another 50% over the next five years as the company grows larger and more mature. If you think Chipotle can clear those expectations and you're happy with 10% annual returns, the stock makes sense.
The goal isn't to predict what the stock will do but work through the process so that you can think through what's likely or unlikely to happen and whether you'd be happy with the result. The stock doesn't seem cheap today, but the numbers show that Chipotle can still be a solid long-term investment if the business keeps growing.
Fortunately, you can do two things to help increase your chances for success; first, you can hold stocks for a long time. As long as Chipotle continues growing earnings, you'll more likely make out better the longer you hold shares. Second, you can slowly accumulate shares using a dollar-cost average strategy. That way, you'll run less risk of jumping into a stock at the wrong time (which is often apparent only in hindsight).
