Warning: Before You Buy Chipotle Stock, Know This 1 Key Risk

With its shares up a jaw-dropping 335% in just the last five years, investors clearly have a strong appetite for Chipotle Mexican Grill (CMG 0.74%). This monumental gain significantly exceeds both the S&P 500‘s and the Nasdaq Composite‘s returns, as well as those of most of the “Magnificent Seven” constituents.

Despite macroeconomic headwinds and uncertainty, this Tex-Mex restaurant chain has proven its resilience. And the business is currently firing on all cylinders.

But don’t rush to buy the stock just yet. There’s one key risk that you simply can’t afford to miss.

Booming business

Just like the consistency of its popular burritos and bowls, Chipotle once again crushed analyst estimates last quarter, something that’s becoming a usual occurrence. During the three-month period that ended Dec. 31, the company reported that revenue and diluted earnings per share increased 15.4% and 27.3%, respectively, compared to the prior-year quarter. This helped drive shares higher immediately following the news.

Same-store sales were up 7.9% in 2023, boosted by strong transaction growth. This is extremely encouraging to see. Inflationary pressures don’t appear to be keeping Chipotle customers from frequenting the stores. This illustrates the tremendous value they see in what the food the company offers.

On the profitability front, things just keep getting better. The business posted an operating margin of 15.8% last year, an expansion from 13.4% in 2022. Because Chipotle has large fixed costs for things like lease payments and labor, it can benefit more from economies of scale over time. The margins also get help from consistent menu price hikes.

Thanks to Chipotle’s strong fundamental momentum, Wall Street couldn’t be more optimistic. Analysts expect revenue to increase at a compound annual rate of 13.8% over the next three years, with adjusted EPS rising at a yearly clip of 20.3%.

Priced for perfection

If we looked at just the underlying business and its performance, it’s hard to find anything to dislike about Chipotle. The company is flourishing.

But that doesn’t mean the stock is a no-brainer buy right now. It’s critical investors also assess the valuation that the market is presenting them with. After their terrific gains, shares currently trade at a forward price-to-earnings (P/E) ratio of 49.2. In my opinion, this means Chipotle is priced for perfection.

Astute investors will quickly point to Chipotle’s fantastic growth profile as enough of a reason to justify the steep P/E multiple. Management is doing a good job giving shareholders optimism.

“I am more confident than ever that we have the right people and the right strategy to achieve our long-term growth goals of reaching 7,000 restaurants in North America, $4 million in AUVs, expanding our industry leading margins and returns and furthering our purpose of Cultivating a Better World globally,” CEO Brian Niccol said.

At the end of last year, Chipotle had 3,437 stores, which generated $3 million in average annual sales volume. Clearly, there is still a lot of expansion potential, according to the leadership team.

I don’t doubt that Chipotle can achieve its goals. However, I still think the stock is overvalued.

Let’s assume that Chipotle gets to 7,000 locations, $28 billion in yearly revenue, and a 20% net profit margin by 2033. To be clear, this implies that the business opens stores at a faster rate than it has in the past. And the margin would be much higher than the 12.4% reported last year, which was Chipotle’s best historically.

The current market cap of $71.7 billion is 12.8 times that forecast 2033 net income of $5.6 billion. So, for shares to double in the next decade — a return that lags the S&P 500’s historical performance — investors need the P/E a decade from now to be at roughly an above-market 25. Not to mention the fact that Chipotle would need to post growth and profitability like it hasn’t done before, leaving no room for any hiccups along the way.

This makes me seriously doubt that the stock is a smart buy today. The best move is to wait for a more attractive entry point.