Investors should look at valuation multiples when deciding whether to buy or sell a stock. Valuation multiples are driven by perceived growth, risk and uncertainties, and investor willingness to pay for a stock. There are various multiples used to evaluate a stock. In this article, we’ll use the PE (price-to-earnings) ratio due to its high visibility in Chipotle Mexican Grill’s (CMG) earnings. Forward PE ratio is calculated by dividing the current share price by the forecast EPS (earnings per share) for the next 12 months. CMG forms 0.14% of the holdings of the iShares Russell 1000 Growth ETF (IWF).
Since the beginning of 2016, Chipotle has been trading in the range of 28.3x–80.5x. The rise in PE multiple was mainly due to a decline in expected EPS for the next four quarters. As of April 18, 2016, the company was trading at a PE multiple of 53.2x. Its peers, Panera Bread (PNRA), Brinker International (EAT), and Shake Shak (SHAK), were trading at 30.9x, 12x, and 92.4x, respectively.
From the above graph, we can see that from 2013 to October 2015, the price of Chipotle shares rose as the company posted higher earnings and had expectations of higher future earnings. Its PE multiple was stable as higher expected earnings mitigated the effect of increased share prices. Since the outbreak of E. coli in its restaurants, Chipotle’s share price has been declining. Expected future earnings have also declined. This has led to an increase in Chipotle’s PE multiple.
Risks and uncertainties
To stem the decline in traffic and same-store sales growth, Chipotle has implemented enhanced food safety measures and undertaken massive marketing campaigns to convey its plan to its customers. If the company fails to win back customer loyalty, the increased expenses are expected to put pressure on the company’s margins. For fiscal 2016, analysts are expecting Chipotle to post EPS of $5.90. If the company’s results come in lower, the stock could face selling pressure. That could bring the PE ratio down, and vice versa.
In the final part of this series, we’ll look at analysts’ recommendations for Chipotle prior to its 1Q16 earnings announcement.