Business could hardly be better for Chipotle Mexican Grill (CMG), and today is a big, red-letter day if you own the stock.
Chipotle stock opened with a gain of more than 10% on Tuesday morning after issuing a blowout earnings report after the bell Monday. Earnings came in at $3.50 per share, well above the consensus estimate of $3.09 and 24% above the $2.82 CMG reported a year ago. Same-store sales rose a ridiculous 17.3%, thanks to both higher traffic and the company’s ability to pass on higher costs to consumers — no small feat at a time of anemic wage growth.
The news is all great, and this is reflected in the outsized returns for CMG stock over all time periods.
But if you own shares, the main question now is: What more do you need to see before you sell?
CMG Is Just Too Expensive — Even for a Fast Grower
Chipotle stock was already expensive heading into Tuesday’s rally, and the valuation issue — which has long been fuel for the CMG bear case (so far incorrectly) — is now even more problematic. Shares hit 52 times trailing earnings and 40 times forward estimates on Tuesday morning, and it rose above 5.5 times sales. Comparatively, McDonald’s (MCD) and Yum! Brands (YUM) trade at 15.3 and 17.5 times estimates, respectively, while price-to-sales is 3.4 for McDonald’s and 2.4 for Yum.
It’s true that CMG is growing faster than either of these two companies. It’s also true that Chipotle’s earnings estimates have been rising in recent weeks and continued to do so in the wake of Monday’s report.
But 40 times earnings is far too high of a price to pay — even for the kind of growth CMG stock is generating. Any miss in execution or future earnings reports, not to mention weakness in the broader market, will hit this stock hard, so owning CMG from the long side is now a bet that the there will be absolutely no interruptions to the positive story.
Looking out past the next few quarters, it’s also a tall order to expect a company of this size — one of the top 240 stocks in the U.S. market and the fourth-largest restaurant operator by market cap — to continue to generate the type of growth that can sustain a 40-plus multiple. And while a 17% pace in its same-store sales is amazing, it’s not realistic to expect that a company of this size can maintain that blistering pace.
The issue of the “high bar” becomes even more acute given that the already insanely lofty expectations for Chipotle stock have only grown following yesterday’s report. A look through the media and analyst coverage of the earnings beat shows almost universal bullishness right now.
An illustration of the potentially limited upside in CMG stock comes courtesy of JPMorgan Chase analyst John Ivankoe, who wrote in the wake of the report, “We continue to see Chipotle as a ‘once-in-a-decade’ type of brand.” This is an impressive statement, and Ivankoe might well be right. However, while boosting his price target by $95, he only took the target to $670 — just a fraction above where shares traded on Tuesday morning.
This is the issue in a nutshell — Chipotle stock is a rare growth opportunity, but it’s also one where the stock might not have much further to run.
Click to Enlarge This is underscored by the extremely high returns that are already in the rear-view mirror for Chipotle stock. CMG shares have gained 32% just since April 30 and sport an average annualized gain of nearly 50% during the past five years.
Past performance alone isn’t a reason to sell, of course, but with gains of this magnitude already in the books, how much more can investors expect to wring out from here?
In this sense, the risk-reward trade-off in CMG stock is no longer as compelling as it was even a few months ago.
The Bottom Line
Chipotle is putting up great numbers, and that’s an attractive attribute at a time in which shaky global growth continues to pressure the top-line outlook for most large-cap companies. But everything has a price, and CMG stock clearly has reached a level where investors are overpaying for growth.
Hats off to you if you’re astute enough to own Chipotle stock, but now it’s time to cash in. Take advantage of this rally by hitting the sell button with both hands, and look for a chance to get back in at a better valuation. Forty times forward estimates is just too expensive for a restaurant stock — even for a growth stalwart like CMG.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.