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The challenge of growth-stock investing is three-fold.
First, you have to be able to stomach the volatility. Popular growth stocks can swing in price on a daily basis, sometimes as much as a hundred dollars on a day it reports earnings.
Second, you have to be careful not to be enticed when momentum takes over and the stock becomes too expensive, leaving you exposed to a sudden sharp drop.
Third, you have to recognize when the time is right to get out, such as when a company’s big growth phase has ended.
These are the challenges investors face with Chipotle Mexican Grill (NYSE: CMG). Simply put, the company and its results have been going gangbusters for several years. Those who were skeptical about the company’s ability to continue growing have seen the stock soar while they have sat on the sidelines.
Those people shouldn’t be too hard on themselves. Who would have expected Chipotle to expand to 1,700 locations?
So is it too late to get on board? I don’t think so, and I’ll tell you why.
Changing the Mexican-Food Model
The key to any restaurant concept is its staying power. Remember the bagel craze that kicked off about 20 years ago? Bagel joints were everywhere. Lines were always long. Then it petered out. Bagels simply didn’t have staying power since they are primarily a breakfast item.
P.F. Chang’s was successful because it took the concept of Chinese food, a perpetual favorite in America, and made the food and the restaurants a bit more upscale. Chipotle has effectively done the same thing with Mexican food, another American favorite. You don’t have to set foot in a crappy hole-in-the-wall that serves mediocre, unhealthy food to get your Mexican-food fix.
Chipotle, however, went one step further than P.F. Chang’s. It not only offered better food in a standardized environment, it made its food healthy (relatively), and delivered it quickly. I have never spent more than five minutes in a Chipotle line, no matter how long it was.
The food is good, the quality is consistent, the prices are reasonable, and there is no wait.
Simple wins the day. There is no reason why Chipotle cannot take on every one of the approximately 28,000 Mexican restaurants in the United States. It has 6% of the Mexican food market share, which means there’s a lot more to grab. Its growth should continue for some time.
Furthermore, like P.F. Chang’s and Cheesecake Factory (NASDAQ: CAKE), people just don’t seem to be getting tired of it – despite a fairly simple menu. If it ever needs to spice things up, Chipotle could easily add to its menu options.
Debt-Free Cash Cow
The key metric to measure a restaurant’s growth are its same-store sales. If a company is generating mid-single-digit revenue growth, that’s considered good. High single-digits is considered great.
Chipotle’s same-store sales are better than great. They increased 19.8% in Q3, and 17% YTD. That’s incredible. Furthermore, management said it expects that rate to continue for Q4 before dropping into mid-single-digits next year.
Chipotle has always expanded with care and prudence. Management hates to carry debt, and the stores generate such robust cash flow that they don’t need to. Free cash flow was $260 million in FY11, $220 million in FY12, $327 million in FY13, and already at a whopping $348 million for the first three quarters of 2014.
The company carries $442 million in cash and $440 million in long-term investments, totaling about $27 per share in cash and, again, no debt.
Valuation
Is Chipotle stock still a buy, even if it trades at $648 per share? First, let’s back out the $27 per share in cash, so we see the business is actually valued at $621 per share.
FY14 EPS is expected to be $14.03 per share, up 35% YOY. FY15 EPS is expected to be $17.44, up another 24%.
Thus, CMG trades at 35x next year’s estimates. Analysts see annualized growth over the next five years at 24%. Thus, the PEG ratio is a bit under 1.5. For a growth stock that has this kind of cash flow, no debt, and so much blue-sky opportunity, I think the stock is fairly valued.
Growth investors seeking 24% annual appreciation should feel compelled to buy Chipotle stock, even at such a lofty share price.
The Real Story Behind Apple’s Success
Apple’s new iPhone 6 is another smash hit for the kids from Cupertino. While we love Apple, we’re recommending a company today I’ll bet you’ve never heard of. This company provides the technology that makes every smartphone – both Apple’s and Samsung’s – possible. Even better – shares of this company rocket five times higher than AAPL shares – every time a new iPhone hits the market. Click here for the full story.