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, 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 forecast EPS (earnings per share) for the next 12 months.
Chipotle’s PE multiple
The improvement in December 2016 SSSG (same-store sales growth) and measures adopted by the company to improve its SSSG appear to have increased investors’ confidence. It led to an increase in Chipotle’s stock price and its PE multiple. As of January 10, 2017, Chipotle was trading at 46.4x compared to the previous day’s PE multiple of 43.8x.
From the above graph, you can see that Chipotle is trading above its peers’ median valuation multiple. After the food safety issue, analysts’ EPS forecasts are on the lower side. It led to the rise in Chipotle’s PE multiple. On the same day, Chipotle’s peers Shake Shack (SHAK), Panera Bread (PNRA), and Brinker International (EAT) were trading at 63.5x, 27.9x, and 13.2x, respectively.
For the next four quarters, analysts expect the company to post EPS growth of 126.1%. Chipotle’s current price might have factored in sales growth. If the company reports lower-than-expected EPS, the stock could face selling pressure. It could also bring the valuation multiple down and vice versa.
You can mitigate these company-specific risks by investing in the iShares US Consumer Services (IYC). IYC has 11.5% of its holdings in restaurants and travel companies.
Despite the recent surge in Chipotle’s stock price, analysts are still maintaining their price target for the next 12 months at $394.8. It represents a fall of 4.7% from its current price. Of the 37 analysts that follow Chipotle, 29.7% have a “buy” recommendation, 57.6% have a “hold” recommendation, and 18.9% have a “sell” recommendation.