Yes, Chipotle Can Get Hotter

There are two ways to get stuffed on Chipotle Mexican Grill (NYSE:CMG). The first way, of course, is to head out to your closest Chipotle and order a fajita burrito. Try the barbacoa or carnitas variety if you want something a bit off the beaten path.

The other way is to bet against the company, only to watch your short position explode in your face like a tightly squeezed burrito. That's the way things have gone for Chipotle, with its shares soaring nearly fivefold since going public at $22 a share 19 months ago.

So far, so good. The problem is that investors are always concerned about the future. So many growth stocks -- even the great ones -- get to a point where their share gains outpace the spurts in fundamentals. Like Wile E. Coyote going too far off the cliff in pursuit of the speedy Roadrunner, it's too easy to defy gravity until you see nothing but air down below.

Chipotle's stock lapped the $100 mark earlier this month. That nice round number says little in terms of valuation, yet the rarity of an eatery stock trading in the triple digits is leading investors and financial journalists to wonder whether Chipotle's shares have gotten too spicy for their own good. Just check out the following headline out of this weekend's Barron's, in Johanna Bennett's Weekday Trader column:

Has Chipotle Gotten Too Hot?  

You can probably guess the answer. A high P/E multiple, negative trends in restaurant stocks, and a history of sizzling casual-dining IPOs that went on to fizzle out of favor are working against Chipotle, claims the article. "Investors looking to spice up their portfolios may want to order something else from the menu," Bennett concludes.

I disagree, but you probably could have guessed that, too.

A stock pico de gallo
I recommended Chipotle to Rule Breakers subscribers earlier this year, when it was trading at $60.60. The shares have since soared another 68%. A few days later, Bill Mann went with the more attractively priced, though less frequently traded, Class B shares (NYSE: CMG-B) for Hidden Gems newsletter readers. His sharp call is showing a 70% gain in that time.

I don't expect you to put more weight in my argument just because I was right before. Bennett may very well win this round. However, I think many of the assumptions in the article are as flawed as the bearish theories that have burned shorts so far.

Let's start with the valuation. Yes, Chipotle's shares aren't priced for the vultures. The stock is trading at slightly more than 50 times this year's Wall Street profit targets, and 41 times next year's projected profitability. That may not seem cheap, but we also have to consider the source. Analysts have done a lousy job of guessing Chipotle's true earnings power.

Seeing Chipotle smoke Wall Street in its first seven quarters as a public company is encouraging. Notice the acceleration of the upside in the last two quarters, which suggests that analysts are getting even worse at gauging the company's true income-producing power.

"Yet it always pays to remember that Wall Street often does not take well to earnings disappointments -- even when a company's performance numbers are otherwise healthy," Bennett writes, before issuing her spicy pun at the end.

This company certainly doesn't look like it's disappointing anyone. If anything, the pros have been perpetually raising their expectations with every lowball guesstimate. Before this month's blowout report, analysts were looking for Chipotle to earn just $1.72 per share this year, and $2.17 a share come 2008. Three months ago, as they were digesting yet another humbling zinger of a quarter, Wall Street was looking for $1.58 a share in 2007, and $2.00 per share next year. With bottom-line estimates per share now perched at $1.98 and $2.49, respectively, history indicates that the targets will keep inching higher. As long as share gains come at a slower pace, the forward P/E will shrink.

As for the industry malaise, with leading chains posting weaker traffic, that's old news. Chipotle has been able to keep its comps growing, a testament to the concept's buoyancy, as well as the willingness of patrons to absorb menu hikes to coincide with rising food costs.

Sure, once-high-flying IPOs like Panera (NASDAQ:PNRA) and P.F. Chang's (NASDAQ:PFCB) had their brushes with mortality, but they've gone through expansion pains and soft comps this year. Panera had a solid July, but Chipotle has been consistent throughout its public tenure.

Splitting headache
Betting against Chipotle at this point may also be dangerous, because a stock split feels inevitable. As consumer-oriented stocks, successful eateries tend to split their shares when they grow too high. Dairy Queen parent Berkshire Hathaway (NYSE:BRK-A) is an obvious exception, though if you stick with pure eatery plays, you have to go all the way down to IHOP (NYSE:IHP) at $65 to find a sector stock even approaching Chipotle's price tag. The chances of a 3-for-1 stock split in the near future are probably better than 1-in-3.

Stock splits don't change the fundamentals, though they often provide a psychological boost, as investors feel that the future is bright enough to warrant authorizing a stock split.

There are other holes in the bearish article. The company's food, beverage, and packaging costs will rise 31% this year, warns a Lehman analyst. That's misleading if you don't realize that revenue has risen 30% through the first six months of the year. Pointing at insider selling is another shot, though the article never explains that it's a small percentage of insider holdings (and that CEO Steve Ells is selling as part of a prearranged 10b5-1 diversification plan).

Sure, Chipotle can always stumble in the future. Rivals Baja Fresh and CKE Restaurants' (NYSE:CKR) La Salsa both hit brick walls. However, like Jack in the Box's (NYSE:JBX) fast-growing Qdoba chain, Chipotle is simply seeing that as an opportunity to expand into hungry markets.

So leave the stuffing to the burrito-chomping meal, and let the taxidermists worry about stuffing bears for a living.

Chipotle was recommended in both Hidden Gems and Rule Breakers six months ago. Which of the two stock research services is the right one for you? Check either one out with a free 30-day trial subscription offer.

Berkshire Hathaway is both an Inside Value and Stock Advisor selection.

Longtime Fool contributor Rick Munarriz can't wait for a Chipotle to open closer than 25 miles away from his Miami home. He can presently walk to a Salsarita or jog to a Baja Fresh and a pair of Qdobas. A Chipotle is opening soon in North Miami, but that's still nearly a 20-mile trek. He does not own shares in any of the companies in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool's disclosure policy keeps things spicy, but won't give you heartburn.