Why Chipotle Mexican Grill, Inc. Stock Is a Knife Worth Catching

Chipotle stock - Why Chipotle Mexican Grill, Inc. Stock Is a Knife Worth Catching

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Chipotle Mexican Grill, Inc. (NYSE:CMG) reported earnings last night and Wall Street hated what they saw. CMG stock is down more than 10% and now it is a falling machete.

Even though recently CMG stock had a decent run, it came into the earnings event down 25% in 12 months and 60% off its all time high. Needless to say, the stock went from investor darling to serial disappointment.

This is not entirely due to the business model. Few companies could have survived the healthcare headlines that CMG endured. And as a consequence, it lost the ability to deliver insane comp sales. Indeed, last night they told us that comp sales will be smaller than anticipated in 2108.

For a while, investors flocked to Chipotle stock because of its incredible comps, so it earned a value premium to other restaurants. That is now gone, yet it still carries relative froth and this morning it is shedding some of it. Analysts are still not realistic with their expectations. This morning CMG earned two downgrades and one was to a sell, yet it still carries a huge value premium to all of its competitors.

How to Trade Chipotle Stock

CMG stock is bloated. Its price the earnings ratio is two and a half times that of McDonald’s Corporation (NYSE:MCD). I know die-hard fans of Chipotle stock would retort that MCD is not a fair comparative. But to that, I submit that they are both competing for the same restaurant investing dollars. MCD is now the darling restaurant that can do no wrong.

So given all the negativity so far in this write-up, you might think I want to short the stock. But I actually want to set a bullish trade in CMG stock. However, this trade is more so a bet on price action than valuation. As such, I consider this a speculative trade inside a conservative portfolio.

I realize that CMG management has its work cut out for it to fix its business model and they need to come to terms with their new reality. MCD knows what it is and delivers great margins. Chipotle is trying to live up to its past stock glory days instead of embracing its current new normal. Some of the steps they noted in their report appear to be heading in the right direction.

My bet today is more so that the extreme downside of some bears is not likely to happen. So I will use CMG options to create income thereby leaving a huge room for error. What helps is that the stock market had already shed 14% of the froth that was in the stock ahead of the earnings, so we could be closer to a bottom soon.

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Keep in mind that the worst case scenario to my trade is to own the stock at a xxx% discount. If so, I am confident I can manage out of them with minimal damage. So I consider this as a somewhat speculative trade inside a conservative portfolio.

The Bet: Sell the CMG Jun $185 put and collect $2-per-contract to open. There’s a 85% theoretical certainty that I retain maximum gains. Otherwise, I will accumulate losses below $183.

Selling naked puts carries big risk, especially for a stock as frothy as CMG stock. For those who want to mitigate it, they can sell a spread instead.

The Alternate Bet: Sell the CMG Jun $185/$180 credit put spread. The spread has the same odds, but would deliver 10% yield on risk.

Today’s trade doesn’t need a rally to profit, although it would certainly benefit from one. I merely need Chipotle stock to hold its support for the next few months. It is important to know that if they do, then I want to own the shares at a discount from here.

Ultimately, investing in stocks is fraught with danger, so I never risk more than I am willing to lose.

Get my newsletter for free here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.

Article printed from InvestorPlace Media, https://investorplace.com/2018/02/chipotle-mexican-grill-inc-cmg-stock-knife-worth-catching/.

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