Is Chipotle stock overvalued? | The motley fool

With the market in turmoil this year — and many companies seeing their stock prices hammered — it might seem like almost any stock is cheap. Some popular consumer-oriented tickers in particular are selling at historically low valuations, which could entice investors to board.

But make no mistake. There are still stocks that could be expensive, despite the weak market performance this year. Chipotle Mexican Grill (GCM -1.87%) comes to the top of my mind. It’s a winning investment, but it may be wise to think twice before becoming a shareholder in this best restaurant stock.

Chipotle’s business flourished

While many restaurant businesses struggled just to survive during the pandemic, Chipotle thrived. Relying heavily on its digital infrastructure that allows hungry customers to order for pickup or delivery, the company has strengthened its competitive position in recent years. After increasing by 7.1% in 2020, sales jumped by 26.1% in 2021.

Unsurprisingly, tough comparisons led to a slight slowdown, with same-store sales, or comps, rising 10.1% in the second quarter from 31.2% in the year-ago period. Additionally, rising costs for things like beef, avocados and labor are putting pressure on margins.

Chipotle will announce its third quarter financial results on Tuesday, October 25, after the market closes. Management expects same-store sales to grow mid to high, which would represent a marked slowdown from recent quarters.

Nonetheless, the company’s long-term prospects remain as strong as ever. Management thinks there might be a day 7,000 Chipotle locations in North America, compared to 3,052 today. Additionally, they believe that each store could generate at least $3 million in annual unit volume (AUV), up from just over $2.7 million today, with the expectation that this could increase further with the time.

That’s a rather optimistic outlook for a company that has already shown tremendous success. Even so, don’t rush to buy the stock right away.

Stock looks expensive

As things stand, Chipotle shares are selling for a price/earnings ratio (P/E) multiple of 57. This valuation means the stock is more expensive than other popular restaurant stocks, such as McDonald’s, Dominos Pizzaand Starbucks. To be fair, Chipotle has a bigger growth opportunity than these peers, but that’s not enough to justify the valuation.

Even if the company can somehow manage to open 400 stores a year over the next decade to reach the 7,000 mark in North America, an annual rate that has not been reached in the history of Chipotle , while hitting $3 million in AUV, the stock still looks pricey. With a profit margin of 15%, up substantially from the 10-year high of 10.8%, and estimated sales of $21 billion, that equates to $3.2 billion in profits in 2032.

I think it’s reasonable to assume that Chipotle’s current P/E ratio will compress as the company matures. So if we apply a multiple of 28, or about half the current valuation, the company will be valued at $82 billion in 2032. Compared to the current market capitalization of $42 billion, this implies twice the share price over the next decade, or about 7% per year, hardly a robust return. And remember, this is an extremely bullish scenario where Chipotle is opening more stores each year than it has ever opened in its entire history.

But one thing Chipotle has going for it is its powerful brand, which has only gone from strength to strength over the past two years. This creates an added advantage for the investment situation, particularly if executives determine that they have underestimated the growth opportunity. This was the case recently, as the store target was pushed to 7,000 from 6,000 previously. Obviously, if that number goes up again, it would make the stock cheaper.

However, this outlook doesn’t give investors any leeway as the optimism surrounding Chipotle’s outlook appears to be fully priced into the stock and more. Accordingly, I believe the best course of action for investors is to wait for a significant pullback before buying stocks.