Valuation multiples are driven by investors’ willingness to pay for a stock and the stock’s perceived growth, risks, and uncertainties. These multiples help investors to make investment decisions.
Analysts use various multiples to evaluate a stock. Due to the high visibility in Chipotle Mexican Grill’s (CMG) earnings, we’ll be using the forward PE (price-to-earnings ratio) in this analysis. Forward PE is calculated by dividing a stock’s current price by its forecast EPS (earnings per share) for the next 12 months.
Before the announcement of Chipotle’s 1Q17 earnings, analysts expected EPS (earnings per share) of $8.93 for the company over the next four quarters. After the company’s strong 1Q17 earnings, analysts raised their estimate to $9.31. This rise led to a fall in Chipotle’s forward PE. On April 27, 2017, Chipotle was trading at a PE of 49.9x, compared to its level of 50.7x before the announcement of its 1Q17 earnings.
To drive its same-store sales growth, Chipotle has implemented Smarter Pickup Times technology in all its restaurants and has also launched a marketing campaign, “As Real As It Gets.” These initiatives are expected to increase Chipotle’s expenditure. If these initiatives fail to generate the expected sales, the increased expenditure is expected to put pressure on Chipotle’s margins, lowering its earnings.
For the next four quarters, analysts expect Chipotle to post EPS growth of 144.2%, which may be factored into its current stock price. If the company’s earnings come in lower than expected, selling pressures could lower its PE.
You can reduce these company-specific risks by investing in the iShares US Consumer Services ETF (IYC), which has invested 11.6% of its holdings in restaurant and travel companies.
Next, we’ll look at analysts’ target price and recommendations for Chipotle.