Chipotle Mexican Grill (NYSE: CMG) has undoubtedly been one of the best businesses to have owned in the past five years, with shares of the restaurant stock soaring 228% since July 2019. That gain crushes the performance of the S&P 500 by a wide margin.
This booming fast-casual chain just revealed its latest financial results, which were impressive. Nonetheless, shares have fallen 26% since hitting a peak in June, even though they have made investors rich in recent years.
Before rushing to buy this stock on the dip, it's critical to be aware of what I believe might be the biggest risk that Chipotle shareholders face.
Chipotle is firing on all cylinders
I think it's worthwhile to appreciate what Chipotle has been able to do. The company once again reported a fantastic quarter. This bucks the trend of the struggles facing the retail and restaurant sectors.
During the three-month period that ended June 30, Chipotle posted 18.2% year-over-year sales growth. The $3 billion in revenue was 129% higher than five years before in Q2 2019. This is a much larger enterprise than it was prior to the pandemic, which is clearly an indication of the company's ability to cater to changing consumer behavior, particularly around digital ordering.
Not only did Chipotle beat Wall Street estimates on the top line, but diluted earnings per share (EPS) of $0.33, which equaled a jaw-dropping 32% gain versus Q2 2023, also exceeded analyst expectations. Despite ongoing inflationary pressure for avocados, operating margin expanded 250 basis points.
Same-store sales surged 11.1% higher, driven mainly by higher transaction counts. This demonstrates robust traffic. Looking ahead, management maintained guidance for same-store sales growth in the mid- to high-single digits. And for all of 2024, the plan is to open between 285 and 315 new restaurant locations.
Chipotle shareholders face a major risk
The restaurant industry is tough because there are no barriers to entry for new competitors, and no switching costs for consumers. This creates a hypercompetitive backdrop. However, this isn't the key risk I see with Chipotle.
Because the stock has performed so well in recent years, it has become extremely expensive. Shares trade at a price-to-earnings (P/E) ratio of 50 right now, even after the latest 26% dip in the stock. For what it's worth, Chipotle's valuation is currently 56% higher than the tech-heavy Nasdaq-100.
Of course, the company's valuation can be justified if Chipotle was going to produce monster growth going forward. According to Wall Street consensus analyst expectations, revenue and EPS are projected to rise at compound annual rates of 14% and 21%, respectively, between 2023 and 2026.
I don't believe that warrants the expensive P/E multiple. In fact, even if we assume Chipotle can grow EPS by 21% annually through 2030 -- which is a lofty forecast, in my opinion -- then the stock still trades at 15 times 2030 estimated EPS of $3.38. This doesn't create a favorable setup to achieving adequate returns.
I'll admit that I've been wrong before. I've previously argued that Chipotle's P/E ratio was too rich, but the stock has kept climbing higher. I still stand by this perspective. It seems ridiculous to me to want to pay a P/E multiple of 50 for this business.
If someone were to purchase shares today with the intention of owning for five or 10 years, I think there's a virtual certainty that the P/E ratio will come down significantly. That's especially true when you consider that Chipotle will become a more mature company over time, with declining growth prospects.
The stock appears priced for perfection today, giving prospective investors almost zero margin of safety.
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Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill. The Motley Fool has a disclosure policy.
1 Risk That Chipotle Investors Will Regret Not Knowing was originally published by The Motley Fool