It’s hard for anyone to disclaim just how wonderful an investment Chipotle Mexican Grill(NYSE: CMG) has been. Its shares have catapulted higher in the previous few years because of a powerful financial performance.
The indisputable fact that Chipotle has proven to be an excellent business that has compounded shareholder capital implies that it must be in your investing radar. Nonetheless, it is best to learn about one key warning before buying this unstoppable restaurant stock.
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Up to now five years, Chipotle stock has soared 307%. That gain easily outpaces the S&P 500 by a large margin, which has generated a complete return of 111%. Even this yr, Chipotle has done higher than the broader index.
However the warning that investors should heed is Chipotle’s sky-high valuation. The stock trades at a price-to-earnings (P/E) ratio of 56.3 as of Nov. 12.
To be fair, this valuation is lower than the P/E ratio of 72.6 that shares sold for at their all-time high in June this yr. Some investors might view this slight pullback as a smart buying opportunity. But I do not feel this fashion.
Chipotle’s expensive valuation means there isn’t any margin of safety for prospective investors, in my view. It demonstrates just how much optimism and enthusiasm the market has for the business and its prospects. Based on Chipotle’s financial performance over the past few years, that bullish perspective is comprehensible.
Investors should realize that a high P/E multiple creates a serious hurdle to achieving strong returns. In other words, it shows that Chipotle may be priced for perfection straight away. Should same-store sales and margins are available in worse than the market expects in any given quarter, the shares will take successful.
This begs the query: At what valuation is the stock a buy candidate? I’d must see the P/E ratio get below 30 in an effort to get interested. I’m unsure if it will ever occur. But I will be keeping tabs on what Chipotle’s business and stock are doing, patiently waiting for the precise opportunity.
It is important to separate a stock’s valuation from the underlying business. While the previous is not attractive today, the latter points to an excellent company.
Chipotle has exhibited solid growth between the third quarters of 2019 and 2024, with revenue doubling over those past five years. This has been partly driven by robust same-store sales gains. Nevertheless it has also come from a rapidly expanding store base.
Since 2019, Chipotle has opened 1,069 net recent locations, a lot of which were built with drive-throughs, called Chipotlanes. And the corporate still has a lot of expansion potential. The outlook calls for 7,000 stores in North America someday, which might double the present footprint.
Each Chipotle location continues to generate more sales with each passing yr. Due to this fact, it is easy to know why the management team is so focused on further expanding the shop base, especially since additionally they boast a restaurant-level margin of 25.5%.
This can be a highly profitable organization. Since Q3 of 2019, net income has climbed at an annualized pace of 31.5%. Chipotle is proving that it may well operate exceptionally well, particularly because it scales up and higher leverages its expenses to drive ongoing efficiencies.
In accordance with Wall Street consensus analyst estimates, earnings per share are expected to rise at a compound annual rate of 18.9% between 2024 and 2026. Despite the fact that that may be a notable slowdown, it’s still a positive outlook. Nevertheless it doesn’t justify paying the present P/E ratio.
There isn’t any doubt that Chipotle is a high-quality enterprise. Nonetheless, the valuation just is not compelling straight away. It is best so as to add this business to your watch list within the hopes of a large pullback.
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Neil Patel and his clients don’t have any position in any of the stocks mentioned. The Motley Idiot has positions in and recommends Chipotle Mexican Grill. The Motley Idiot recommends the next options: short December 2024 $54 puts on Chipotle Mexican Grill. The Motley Idiot has a disclosure policy.