Chipotle is a high-quality company trading at a discount.
Chipotle Mexican Grill (CMG -1.67%) recently released its earnings report for the second quarter of 2024, the first after its historic 50-for-1 stock split. While the news was positive, it failed to stem the downtrend that began just before the split took effect. Consequently, the stock price has fallen by more than 25% in just over a month.
However, despite the severity of this pullback, it is doubtful any disappointments have undermined the case for investing in Chipotle stock. In fact, investors should either hold their positions or possibly add shares for three compelling reasons.
1. The stock split
From a certain point of view, the stock split is not a reason to buy Chipotle or any other stock. After all, 50 shares at $50 per share carry the same value as 1 share worth $2,500, meaning the split makes no difference in the ownership stake or value of one's Chipotle shares.
Nonetheless, the action could increase its value on the margins. For one thing, small investors who are unwilling or unable to buy partial shares can now afford whole ones. That should increase the demand for shares. It should also prevent liquidity from falling to low levels, ensuring small investors can buy and sell at the prevailing market price.
Moreover, liquidity should also rise because selling covered calls just became more affordable. To initiate such an action, one has to buy 100 shares, which cost about $5,000 at $50 per share. Before the split, 100 shares at $2,500 per share would have cost $250,000, making such an action unrealistic for most investors.
2. Recession resistance
Second, sales have remained strong despite uncertainty in the economy. Due to three years of elevated inflation, consumers increasingly find themselves unable to cover basic expenses, let alone eat in restaurants.
However, Chipotle's growth seems to continue as if this suffering was not occurring. One reason is likely its menu pricing. Amid economic struggles, Chipotle remains a place where one can buy a low-cost meal made with natural ingredients at a low price. And so low are its prices that its price increases in recent quarters have not deterred growth.
- In the first two quarters of 2024, revenue of $5.7 billion rose 16% compared to the same period in 2023.
- An increase in comparable-restaurant sales of 7% in Q1 and 11% in Q2 contributed to the rise.
- Also, Chipotle opened 93 additional restaurants during the first half of the year, bringing the total number of locations to 3,530.
- Such improvement led to a net income for the first two quarters of the year of $815 million, a 29% yearly increase.
- During that time, Chipotle limited its expense growth to 14%, slightly below its revenue increase. This shows it can maintain growth even as costs rise.
3. Valuation
Third, in addition to rising profits, the current valuation might be a blessing for Chipotle investors. The P/E ratio recently stood at 49, which might sound high considering the S&P 500 average of 29. Nonetheless, Chipotle has long traded at a premium, making it likely it would take a historic stock sell-off to take its P/E ratio to the market averages.
Additionally, Chipotle's average P/E ratio over the last five years is 76. Admittedly, the 2021 bull market skewed that figure higher. Also, before the stock had pulled back recently, the earnings multiple was routinely above 65. This might have created an environment in which it would take a perfect earnings report to prevent a sell-off in the stock.
Ultimately, the fact that the stock has returned to this level with no significant bad news should probably encourage investors. Given the stock's past behavior and the signs that it is maintaining its revenue growth trajectory, now might be a good time to add shares.
Moving forward with Chipotle stock
Considering the stock's history and the company's continued expansion, the stock looks increasingly like a buy after the recent pullback.
Indeed, the shares experienced a considerable sell-off following a stock split that could make the stock more attractive due to its lower price. Moreover, nothing in the sales numbers indicates the business's performance has worsened.
Still, the valuation moving closer to levels it maintained over the past couple of years bodes well for investors who want to buy now. As the company continues its expansion, the stock should regain that lost value and return to its upward trajectory.
Will Healy has 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.
