Who knew selling beans and rice could be so lucrative? Casual dining brand Chipotle Mexican Grill (CMG 2.41%) has sizzled over the past year. Shares are up a whopping 80%, easily outperforming the broader stock market.
But like its burritos can be, the stock is starting to feel heavy for investors. Remember, a great business doesn't necessarily make an outstanding stock if you pay too much.
So, where does Chipotle stand today, and what should investors' game plan be if they want to own shares?
Chipotle's simple recipe for gains
Sometimes, a business doesn't have to be complex to be effective. Chipotle is pretty simple. The company operates a network of casual dining restaurants that make burritos, burrito bowls, and salads to order. Customers can choose from several proteins and toppings, but the menu is focused. It's also profitable. Chipotle then uses the profits from the business to open up more stores.
Chipotle had 1,755 restaurants at the end of 2014. That's grown to 3,437 as of year-end 2023. How long can this growth go on? You'd be surprised. For comparison, there are nearly 8,000 Taco Bell locations in the United States alone. Additionally, Chipotle is a share cannibal, meaning it repurchases its stock aggressively to help drive earnings per share higher.
CMG Normalized Diluted EPS (TTM) data by YCharts
It's a winning recipe. Chipotle has handily outperformed the broader stock market since 2016. There's no reason Chipotle can't continue this, either. There is plenty of room for restaurant growth over the coming decade. Meanwhile, Chipotle runs a tight ship financially. The company has $1.3 billion against zero debt. All the repurchases are paid for organically with cash flow, so that investors can feel confident they will continue.
The stock's become a bit spicy
If there's one problem with Chipotle today, it's the stock's valuation. To be fair, you'll get that from most stocks that nearly double in one year. Today, Chipotle trades at a forward price-to-earnings (P/E) ratio of 50. Meanwhile, analysts believe Chipotle will grow earnings by an average of 20% annually over the long term.
That seems fair. Revenue grew 14.3% in 2023 due to a combination of same-store sales growth and new openings. Factor in some additional growth from share repurchases, and you're probably close.
CMG PE Ratio (Forward) data by YCharts
Generally, you'd love to own a business that's growing profits 20% annually. However, it's hard to justify paying 50 times earnings for it. The price/earnings-to-growth (PEG) ratio measures a stock's valuation to the company's expected earnings growth. Usually, I like PEG ratios of 1.5 or less, but Chipotle's is a bit higher at 2.5. Investors could easily see diminished returns if shares revert to a lower valuation.
Want to own shares? Consider this
Great companies at high prices put investors in a bind. Nobody knows how long the market will pay a given valuation for a stock. You might get poor returns if the valuation slips after you buy. The opposite could also be true. Chipotle might trade at a sky-high valuation for weeks, months, or even years. You could miss out on the returns if you avoid shares altogether.
That's why a dollar-cost averaging strategy might be best. Investors can buy a little at a time, slowly building their investment in Chipotle. If the price goes down, great! You're going to lower your average cost on the stock. If it goes up, you'll be glad you started buying when you did. It's the closest thing to a win-win you'll get in this situation.
