Generally speaking, restaurants are a lousy business. The failure rate is relatively high, and profit margins are relatively low.
Every now and then, though, certain restaurant concepts just click with people. Chipotle Mexican Grill (NYSE: CMG) is one of those concepts. Fresh, custom-built burritos are a hit! That’s why its top line is expected to grow nearly 14% this year and repeat the feat next year. Half of its recent, comparable growth stems from new store openings; the other half reflects existing-store sales growth. That’s impressive for any consumer-facing outfit, but particularly for a restaurant chain.
This growth, of course, is also the chief reason Chipotle share prices are up 70% for the past year, and higher to the tune of 400% since their pandemic-prompted low in early 2020.
And there’s the rub. The rally is certainly well deserved. But does it leave any meaningful upside for investors interested in stepping into a new stake in Chipotle Mexican Grill?
Answer: Not really.
Chipotle stock is fully valued, if not overvalued
Don’t misread the message. You should expect to pay a premium for quality stock, and Chipotle is definitely that.
There are reasonable limits, however. While paying a price beyond these reasonable limits doesn’t inherently translate into more risk (Chipotle Mexican Grill is going to report the same results regardless of its stock’s price), it does ultimately limit your upside. And, trading at 50 times this year’s projected per-share profits, Chipotle stock is arguably priced well beyond its reasonable limit. For perspective, red-hot artificial intelligence technology stock Nvidia is only trading at 40 times this year’s expected earnings, despite its much bigger growth rate. Amazon shares are cheaper as well, with much more compelling long-term growth prospects than Chipotle.
And analysts generally agree. Whereas the analyst community would normally scoot its consensus price target upward as a stock makes forward progress, in this instance they’ve drawn a firm line in the sand. Their average 12-month price target of $2,764 is a mere 2% above Chipotle stock’s current price. That’s not enough upside to bother chasing.
It happens more often than you might think
Shocked? Maybe you’re a little confused about how something like this can happen?
It’s actually not all that unusual for a rally to take on a life of its own like this one has, driving a stock’s valuation to uncomfortably high levels without anyone ever questioning it. FOMO (the fear of missing out) is a real phenomenon that puts and keeps self-fueling gains in motion … and not just for individual investors.
Most analysts don’t want to be on the wrong side of a trade by suggesting a stock is overpriced right before it logs even more gains. The tech rally seen during the late 1990s is a prime example of how easily this can happen. Analysts were on board with that bullishness too, all the way up until the market peaked, and even after it began imploding in 2000. Too few of them wanted to believe it could happen.
They should have seen it coming, though. As Benjamin Graham explained it so brilliantly: “In the short run, the market is a voting machine but in the long run it is a weighing machine.” Short-term “votes” are generally driven by emotions like fear and greed, whereas long-term “weights” are an indication of a stock’s or the market’s reasoned value.
Right now, investors are voting bullishly on Chipotle. Give them time, though. Sooner or later, this stock’s price will better reflect the underlying company’s results. It’s a restaurant chain that’s growing quite well and is respectably profitable, but hardly to the extent that the stock’s valuation suggests it is.
Right stock, wrong time
Again, don’t misread the message. Or, more specifically, don’t read too much into it. This is the right company, even if it’s the wrong time to buy the stock. Given its penchant for premium pricing, though, you’re probably not going to see what could be considered a bargain price for Chipotle shares anytime soon.
In other words, don’t confuse being patient with being stingy. Any price around $2,100 would actually be a palatable entry point, even though its forward-looking price-to-earnings ratio would still be in the mid-30s at that level.
Perhaps the tougher challenge for would-be investors, however, is the possibility that Chipotle shares could continue making gains from their already lofty price. It would feel like you’re missing out by waiting for a better entry point.
Just don’t freak out or kick yourself if that ends up being the case.
See, investing is as much about risk management as it is about picking the right stocks at the right time. Whether or not this stock moves higher from here, jumping into Chipotle Mexican Grill at this point imposes above-average risk of a pullback once the market finally begins questioning this ticker’s steep valuation. You can find better risk-versus-reward scenarios with plenty of other prospects right now.
Even the CEO is scaling back his exposure
This might help drive the point home: Since the beginning of this year, a bunch of company insiders have collectively sold several million shares of Chipotle stock as soon as they were awarded them. In fact, chief executive officer Brian Niccol sold several million dollars’ worth of Chipotle stock in January alone, extending a streak of selling that’s been underway since early last year. He now owns about one-fourth fewer shares than he did then.
Niccol’s got every right to sell them, to be clear — they’re simply part of his compensation package.
Nevertheless, it is noteworthy that the one person who arguably has the most to gain from the company’s continued growth is choosing to pare back his stock-based exposure to that success. It may well indicate that even he understands Chipotle stock’s rally is getting a little out of hand.
You might want to take the hint.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Chipotle Mexican Grill, and Nvidia. The Motley Fool has a disclosure policy.
Is It Too Late to Buy Chipotle Stock? was originally published by The Motley Fool