The Perfect Burrito Didn’t Yield Perfect Results
Kyle is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Shares of Chipotle (NYSE: CMG) closed down over 20% on Friday after releasing disappointing results. The company actually beat earnings estimates by 11%, but missed on revenue.
Why they’re down so much: In short Chipotle’s shares were priced for perfection. At the market’s close yesterday shares were trading at a price to earnings multiple of 55.55 times TTM earnings, with a 5 year diluted EPS compound annual growth rate of about 26%. This gives the stock a PEG ratio of over 2, not cheap by any standard. The company had to significantly beat earnings, AND revenue in order to continue to stay as high as it was. After slightly missing revenue estimates shares of Chipotle plummeted. The stock did not see the estimate beats that they needed.
The Bullish Case: Chipotle is growing very quickly, and seems to be able to maintain their growth very well. Each year the company is able to increase their store count and this quarter they managed to see same store sales growth of 8%. Additionally they have barely even penetrated the international markets, with almost all of their stores in the U.S. Finally if their Asian Food Concept takes off, shares of Chipotle should grow even faster than expected, which would create tremendous value to shareholders.
The Bearish Case: The stock still seems over-valued. As of this writing the company is trading at an outstanding 44 times earnings. If the company has any more disappointing earnings in the future it is likely that shares of the company will continue to fall.
Where the Stock is Headed: While it is impossible to fully predict the future, I expect Chipotle to continue falling over the coming months as investors recognize the ridiculous price the company is trading at. In order for Chipotle to be a buy, the stock needs to have a lower price to earnings multiple. Just like Microsoft (NASDAQ: MSFT) did at the beginning of the millennium it is possible that Chipotle may grow into its earnings, while shares stay flat. Shares of Chipotle may trade around their current price for a while until earnings finally grow to a more reasonable valuation.
Other Stocks that are Priced for Perfection: Chipotle isn’t the only company to be priced for perfection. Amazon (NASDAQ: AMZN) currently trades at 188 times earnings, and 88 times next year’s earnings. Red Hat (NYSE: RHT) trades at 70 times earnings, and has a five year diluted EPS CAGR of only 16%. If either of these companies disappoint on earnings, shares will likely fall quickly, and investors will take a hit.
A Stock that is Priced for Imperfection: Just as companies that are tremendously overvalued tank on any bad news, stocks that are undervalued skyrocket on any good news. Skullcandy (NASDAQ: SKUL) is a perfect example of an undervalued company. The stock is trading at just under 13 times 2012 earnings, with a five year growth rate of 20%. The company should go much higher on any positive news that is released.
What Now? : Chipotle is a perfect example of what can happen when investors become too enamored by growth. Though growth is important, it is also important to buy the growing company while it is trading at a reasonable earnings multiple. Otherwise investors are likely to take a hit as earnings disappoint, and the stock falls to a lower price.
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Kyle has a long position in the Dec 2012 $10 call on Skullcandy. The Motley Fool owns shares of Amazon.com, Chipotle Mexican Grill, Microsoft, and SKULLCANDY INC. Motley Fool newsletter services recommend Amazon.com, Chipotle Mexican Grill, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.