Once again, Chipotle (CMG) blew away expectations with a strong quarter of revenue growth and earnings, as the food chain saw revenues grow 28% to top $1 billion for the quarter. The stock rose 10% immediately after the report, brining its P/E ratio to 56 and leaving many investors wondering if now is the time to sell.
Before the earnings report, the stock was trading at a TTM P/E ratio of 52, so buying now is buying at a lower discount rate than before the quarter’s earnings. For the last 12 months, CMG’s EPS were 11.49 and, despite strong year-over-year revenue and earnings growth, some investors may be considering now a good time to take gains.
No matter your holding term, it’s difficult to be unhappy with what CMG has given you. In the last year, the stock rose 44% before this quarter’s jump; YTD it was up 10% before earnings. The post-earnings response will bring the stock up to its 52-week and all-time high, so no one selling now will lose any money.
Yet there is always the possibility of lost future gains. How can we know how much we may be losing by offloading CMG?
While there’s no way to know directly, many institutional and professional investors will ask this question as a way of answering that one: how much growth am I expecting, and do I still think CMG can reach it?
First, we need to establish our time horizon. CMG is part of a food trend, and these trends don’t last forever. The healthy fast casual trend is clearly not dying, so let’s assume that it can last another 4 years. Therefore, we are buying and holding CMG stock now in an attempt to profit from CMG’s next 4 years of growth before they happen.
If CMG has a TTM EPS of 11.49, how much can I expect their TTM EPS to be in July 2018? To figure this out, let’s look at the company’s past rate of growth:
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Revenue growth has been uneven, but impressively accelerating over the past four quarters. That acceleration surprisingly continued this quarter, which suggests that we can project a high level of revenue growth over the next four quarters. For simplicity’s sake, let’s assume at least an average of 25% revenue growth over the next four quarters, dropping to 18% for the next four quarters, and then steadily down to a 5% clip by the time of our target quarter of 2Q18:
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Here we see a model of CMG’s future business taking shape, and we have a target revenue figure for our time horizon. Now we need to calculate an EPS expectation. For that, let’s assume a steady operating margin from this quarter’s figure. This is a very crude, overly simplistic assumption (companies have seasonal margin fluctuations in many cases and can improve margins in all cases), but it will serve for our purposes for now:
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This quarter, CMG reported net incomes that were 10.5% of sales; assuming that number stays steady, our EPS for 2Q18 rises to 6.02 and the TTM EPS of 21.56.
Now calculating the stock price we expect CMG to reach in 2Q18 is quite easy, but we need to think of one more thing: the market average. What P/E ratio should we expect for CMG when it becomes mature? To establish this benchmark, we could look at the P/E ratios of established fast-food and casual restaurants like McDonalds (MCD, P/E 17.7) and Darden Restaurants (DRI, P/E 23.6). These two stocks alone get us to a P/E of about 20, which is only slightly higher than the S&P 500 average of 19.6.
Using 20 as our baseline, our target price for CMG in 2Q18 becomes $431.20, which is obviously substantially lower than what the market is expecting. This model would tell us to sell CMG and buy back when it falls below that price.
However, this model is crude and imprecise, as I have warned. My growth figures of 25% and 18% are wholly arbitrary. My thesis of growth deceleration beginning this quarter and continuing unabated until 4Q18 has no basis in reality. In other words: I need to do some due diligence to perfect my analysis.
How can I do this? One good way would be to look at CMG’s new restaurant expansion rate and same-store-sales rates. Another way would be to see if the company is creating new brands and growth drivers, and how successful they are. Another way would be to look at average ticket prices, price increases for menu items, and new products in existing sales that may or may not cause more growth.
In other words, there are many things that I need to look at and reconsider when perfecting my model. This is what analysts do every day—they look at every aspect of a business to try to find blind spots, and they refine their models as they fill those blind spots with knowledge and information.