Shares of Chipotle Mexican Grill (CMG 2.41%) have been a truly wealth-building investment for shareholders. Over the last decade, it returned 440%, soundly outperforming the S&P 500 index. But some might argue the stock's recent run-up has left it too rich to buy.
Chipotle's current price-to-earnings ratio of 56 is well above the average stock's 22 earnings multiple. Chipotle has a leading online ordering business and a highly profitable business model that has helped the company sustain high, profitable growth over the last few years. Investors anticipate that its growth streak will continue for the foreseeable future.
On the flip side, the high price-to-earnings ratio leaves the stock more vulnerable to a steep slump if the business stumbles.
So what is the best course of action now for current shareholders and those weighing their interest in opening a new position in the stock?
Driving higher profits with new menu items
As inflation heated up last year, Chipotle's revenue growth decelerated from above 20% in the fourth quarter of 2021 to 11% by the end of 2022, and the stock tumbled. But the company surprised investors with accelerating growth to start 2023, which sent the stock surging to new highs.
Revenue grew 17% year over year in the first quarter, with digital sales representing 39% of food and beverage revenue. What's most impressive is that this rate of growth is higher than its previous 10-year average annual growth of 12%. This is a 30-year-old restaurant chain still going strong.
No matter how competitive the restaurant business gets, consumers continue to turn to Chipotle for food prepared speedily using fresh ingredients. The company supported its strong quarter with viral marketing on social media platform TikTok that leveraged its new Fajita Veggies and Chipotle Honey Vinaigrette, menu items that the company said doubled its quesadilla business.
Importantly, these new menu items were made with existing ingredients, so the incremental surge in demand for them pushed profits up without increasing complexity in the restaurants. Adjusted earnings per share surged 84% year over year in the quarter, partly due to lower avocado prices and tight cost controls.
This continued its trend of strong earnings growth in recent years.
CMG Revenue (Quarterly) data by YCharts.
New stores are still a big growth opportunity
Chipotle can clearly continue to drive higher margins and earnings growth through menu innovations. But another attractive aspect of the business that has earned the stock a high valuation is its opportunity to open more stores.
Chipotle opened 41 new locations last quarter, bringing its total footprint to more than 3,200, which includes stores in Canada, the U.K., France, and Germany. Management believes there's room to expand the company's footprint in North America alone to 7,000 locations. It's clear Chipotle is far from done reporting high double-digit-percentage growth rates.
Over the next several years, management expects about 8% to 10% of Chipotle's annual revenue growth will come from opening new restaurants, which means if the company can sustain a similar increase in revenue from existing stores, it could deliver revenue growth of at least 15% per year.
Chipotle has consistently held its comparable sales growth -- sometimes referred to as same-store sales -- in this range. In the year-ago quarter, it reported a 9% comp sales increase, and in the first quarter of 2019, it also reported a 10% increase.
Combine that growth rate with management's history of improving margins, and it's possible Chipotle could sustain earnings growth of around 20% per year.
Chipotle's above-average growth prospects certainly justify a higher valuation than the average stock in the S&P 500 index.
Data by YCharts.
Is Chipotle stock worth buying at these highs?
The stock is trading at an expensive valuation, and there are always risks of events that could send it down sharply, such as a food-borne illness outbreak of the sort that the company has endured before.
A greater concern for this company will be its need to maintain a consistent operating culture. As Chipotle further expands its restaurant base, it will be imperative for it to keep delivering a consistent dining experience. This is a great challenge for all restaurant chains, and some succeed while others fail.
Chipotle is showing signs of growing into one of the elite global restaurant businesses. Even as it continued to expand its footprint, Chipotle's return on invested capital (ROIC) reached an all-time high of 45% over the last year. This is a key measure of how efficient a company is at producing profits out of the capital invested in the business. Companies that generate high ROIC over many years are usually rewarding investments.
If you already hold shares of Chipotle, there is no reason to sell. There's still plenty of room for this top restaurant operator to expand. New investors might want to consider adding a small position to a well-diversified portfolio. If the stock dips, they could buy more shares at better valuations to fill out a larger position.
