Cava Group (CAVA 10.50%) is a fast-growing casual Mediterranean chain that just completed its initial public offering (IPO) in June, with the stock up 125% from its IPO price. The restaurant operator is already drawing comparisons to Chipotle Mexican Grill for its similar focus on fresh ingredients and strong growth. Six out of eight Wall Street analysts that cover the stock are bullish. 

Chipotle earned early investors a staggering sum after its 2006 IPO, turning a $1,000 investment on its first day of trading into $49,000 as of this writing. Let's find out whether Cava truly is the next Chiptole, and whether the stock can deliver similar returns.

A small restaurant chain with lots of potential

Chipotle made a name for itself focusing on fresh, high-quality ingredients and a fast checkout lane that won it many fans. The company obviously tapped into a large addressable market with revenue still growing strong to this day.  

Indeed, there are several similarities between Chipotle and Cava Group. Chipotle had only 481 locations in 2005. Cava had 263 restaurants across 22 states in April with some of these locations resulting from the acquisition of Zoe's Kitchen in 2018.  

The market for Mediterranean cuisine could be just as large as Chipotle's market, if not larger. Cava believes it can open over 1,000 locations by 2032. Many people may go out of their way to eat at Cava, considering the well-documented health benefits of the Mediterranean diet. Plus, there could be international expansion opportunities down the road.

Of course, Chipotle is also famous for its digital innovations and slick app that makes online ordering a breeze. Cava shares similar characteristics as it also offers a personalized ordering experience through its mobile app. Digital revenues made up 35% of the business last year, up from just 13% before the COVID-19 pandemic. 

Cava is also demonstrating exceptional revenue growth. The top line has compounded at a 49% rate since 2016 with first-quarter growth clocking in at an impressive 76%. 

One important difference 

The key difference between these companies is apparent in Cava's lack of profits. The company reported a loss of $59 million last year. By comparison, Chipotle notched a small profit of $37 million in 2005 and has been consistently profitable since then. 

Granted, Chipotle already had a footprint twice the size of Cava's by that year, and the latter should see its profits expand as it also grows larger. Cava generated a restaurant-level margin of 25% in Q1 -- the same as Chipotle. 

Beware of Cava's expensive valuation

While there are always execution risks with small restaurant chains, the record of strong growth and healthy restaurant-level margins indicate that Cava has a successful formula.

Still, investors need to be aware that Cava's high valuation could limit its return potential. Chipotle was a small, fast-grower at its IPO, but it traded at a price-to-sales (P/S) ratio of just 2.5. Cava trades at 11 times sales, quite expensive for an unprofitable restaurant chain.

One factor driving stellar returns for Chipotle shareholders was the company's improving margins, which boosted earnings growth. It now generates a net margin of over 11% -- nearly triple the margin in 2006. At Cava's current P/S multiple, investors are already pricing in the potential for it to become the next Chipotle and deliver similar profitability.

Cava stock can still outperform the market, but it will need to continue posting high revenue growth for many years. And if it doesn't move closer to reporting positive earnings per share soon, investors may lose patience and revalue the company at a lower P/S multiple, which would send the stock down.

For what it's worth, analysts expect the company will report negative earnings per share of $0.09 in 2023 before improving to negative $0.07 next year. If it doesn't meet those estimates, there might be trouble for the stock.

If you believe Cava can meet its growth targets, I would start small and add shares as the company's revenue growth and profitability justify a larger position in your portfolio.