Recent times have been anything but normal for investors thanks to the global pandemic and ongoing macro headwinds. However, some businesses have continued to thrive.
In the past three years, shares of Chipotle Mexican Grill (CMG 2.41%) have soared 89%. The Tex-Mex restaurant chain keeps posting strong financial results. And its investors have been rewarded with a gain that exceeds the broader S&P 500.
But where will Chipotle stock be three years from now? Let's take a closer look.
Strong fundamentals
This business has proven its resilience in the past three years, opening new stores and growing sales and earnings in a consistent manner. As we set our sights on 2027, I don't think there's any reason to believe this trend won't continue.
From the end of 2020 through the end of 2023, Chipotle opened a total of 669 net new stores, bringing its current total to 3,437. Over the next three years, it's reasonable to expect a faster pace of openings, as CEO Brian Niccol has mentioned accelerating the launch pipeline.
This is all part of management's plan to one day reach 7,000 stores in North America. Based on Chipotle's strong momentum, it's easy for investors to be incredibly optimistic. And over time, each store is set to generate more revenue, which will lead to greater sales for the overall business.
There's no doubt that Chipotle will continue to lean heavily on its robust digital infrastructure. This includes its successful mobile app and rewards program that allows customers to order for pickup or delivery. In Q4, digital sales accounted 36% of overall company revenue. As Chipotle brings on more loyalty members and, in turn, generates a greater share of business from them, it can boost margins.
I believe a key part of Chipotle's success will be the implementation of occasional menu price hikes. This has been the case in recent years, particularly to offset inflationary pressures on food, packaging, and labor. But given how sales continue to grow, consumers still think they're receiving tremendous value. Consequently, pricing power is another lever for the leadership team to pull.
All of this should result in strong earnings growth. In the past three years, Chipotle's adjusted diluted earnings per share increased at a compound annual rate of 61%. Over the next three years, Wall Street consensus analyst estimates call for an average yearly gain of 20%. That's a marked slowdown, but it still represents a brisk pace.
Investor perspective
It appears as though things will be business as usual for Chipotle. But does this mean it's a sure thing that investors will be rewarded? I'm not convinced about this outcome.
Because of the stock's impressive rise, it's not cheap right now. In fact, I'd argue that Chipotle trades at an expensive valuation. The current price-to-earnings ratio of 62 bakes in a lot of optimism. In other words, the market is fully aware of just how wonderful of a business this is, leaving zero margin of safety for prospective investors.
In my opinion, that steep valuation prices in Chipotle's growth prospects and potential for margin expansion. But if the business misses Wall Street estimates when it reports quarterly results, it could send the stock crashing. That downside risk is something that can't be ignored.
On the flip side, the ideal situation would be to buy a company that's exhibiting strong fundamental performance, but that the market doesn't yet appreciate. This creates a scenario where the valuation multiple could expand, adding a potential tailwind to investment returns. Chipotle doesn't fit in this category.
It doesn't matter how well a business is performing. It's never a good idea to overpay for a stock. While Chipotle is firing on all cylinders right now, I believe there's a high probability that the shares will disappoint investors going forward.
