Chipotle Is a Magnificent Stock. Here's Why You Shouldn't Buy It.

We are almost three months into 2024, and it’s nothing new from Chipotle Mexican Grill (CMG -0.79%). Shares of this popular Tex-Mex restaurant chain are up 27% year to date. And in the past five years, this top restaurant stock is up more than fourfold, crushing the gains of both the S&P 500 and Nasdaq Composite.

In fact, shares have climbed from just $22 when Chipotle went public in early 2006 to over $2,900 per share as of this writing. This incredible run has spurred management to announce a 50-for-1 stock split.

There’s no question Chipotle has been a magnificent stock through most of its history, but that doesn’t mean it’s an automatic buy. Let’s take a closer look at the fast-casual pioneer.

Satisfying hungry shareholders

Revenue and diluted earnings per share (EPS) have grown at annualized rates of 15% and 48%, respectively, in the past five years. Management continues opening new stores at a rapid pace, and the company ended 2023 with 3,437 locations. Chipotle is also heavily focused on its booming digital business, which allows stores to better serve customers while at the same time supporting higher margins.

With average unit volumes climbing above $3 million last year and restaurant-level operating margin expanding to 26.2%, Chipotle is executing at a very high level. This momentum, in the face of ongoing macroeconomic uncertainty, explains why investors have gravitated toward the stock.

Expectations are way too high

While I don’t believe anyone will tell you with a straight face Chipotle is not a high-quality business, that doesn’t mean it’s smart to buy the stock right now.

If you were to invest in Chipotle today, you’d have to pay a premium price-to-earnings (P/E) ratio of more than 65. Even when factoring in its strong results and brand presence, the valuation is just too high.

This becomes increasingly apparent when you consider Chipotle’s growth potential. Management has set a long-term target of operating 7,000 stores in North America, approximately double the current count.

While this seems impressive at first glance, Chipotle’s earnings will need to increase at a truly astounding clip in the coming years to justify the stock’s valuation. Meanwhile, it’s P/E valuation is likely to continue to contract as it has in recent years due to the maturing business.

Investors also might be wondering how the recently announced stock split could affect the situation, but it won’t change anything long term.

Nonetheless, the stock will probably continue to attract a lot of investor attention and enthusiasm, resulting in a stubbornly frothy valuation. Despite the temptation, buying shares of businesses that are priced for perfection is a losing game in my opinion.

Here’s where patience is necessary. Add Chipotle to your watch list, continue monitoring the company, and be ready to buy the stock should the valuation become more attractive.

Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill. The Motley Fool has a disclosure policy.

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