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 investors’ willingness to pay for a stock.
There are various multiples used to evaluate a stock. In this part of the series, we’ll use the PE (price-to-earnings) multiple due to its high visibility in Chipotle Mexican Grill’s (CMG) earnings. The forward PE multiple is calculated by dividing the current share price by the expected EPS (earnings per share) for the next 12 months.
Chipotle’s PE multiple
The euphoria didn’t last long after Pershing Square Capital acquired a 9.9% stake in Chipotle Mexican Grill. Softer growth in restaurants due to a slowdown in the US economy and customers’ continued skepticism about the quality of food being served at Chipotle could have prompted analysts to lower their EPS estimates for the next four quarters. This could have led to a fall in Chipotle’s share price. This brought its PE multiple down. As of September 20, 2016, Chipotle has been trading at 51x—down from 55.7x on September 7, 2016. Chipotle’s peers such as Panera Bread (PNRA), Shake Shack (SHAK), Brinker International (EAT), and Buffalo Wild Wings (BWLD) are trading at 27.6x, 66.1x, 146x, and 25.1x.
In the above graph, you can see that Chipotle’s PE multiple rose considerably since food safety issues struck the company in October 2015. Despite the fall in its share price, the company’s PE multiple has risen due to analysts’ lowering their EPS estimates for the next four quarters.
Risks and uncertainties
With it same-store sales growth slowing down in the US, Chipotle is looking to expand its business in Europe. It also received favorable ratings in a recent survey on policies and procedures adopted by companies to stem excessive usage of antibiotics in meat and poultry. It hasn’t been determined yet how these recent developments will impact Chipotle’s earnings in the next four quarters.
For the next four quarters, analysts expect Chipotle to post EPS of $7.9—year-over-year growth of 11.9%. The current share price might have factored in the EPS growth. If the company’s results come in lower, the stock could face selling pressure, which could bring down its PE multiple. You can mitigate these company-specific risks by investing in the iShares Russell Mid-Cap ETF (IWR). IWR has invested 0.19% in Chipotle.
In the final part of this series, we’ll look at analysts’ recommendations and target prices for Chipotle.