Chipotle Mexican Grill (CMG -1.24%) has been a wonderful business for investors. In the past five years, share prices of the thriving Tex-Mex restaurant chain have risen 298%. That gain crushes the S&P 500's performance during the same period of time.
As of this writing, Chipotle carries a market cap of $89 billion. Its market cap has quadrupled over the past decade. So it definitely has been on a growth track. But can this company become the first trillion-dollar restaurant stock by the year 2040?
What's not to like about Chipotle?
Shares of Chipotle have performed so incredibly well in recent years precisely because the business possesses very attractive characteristics. Here's why this has proven to be a great company.
For starters, Chipotle has pricing power. Management just announced a 2% menu price increase to offset inflationary pressures with key inputs. This adds to a string of occasional price hikes in the past few years. If history is any indication, consumers won't be discouraged from continuing to frequent the chain's restaurants to get their favorite bowls and burritos.
In the past five years, revenue increased at a compound annual rate of 14.9%, boosted by the combination of new stores, higher average ticket sizes, and greater foot traffic. This is what all retail-based enterprises hope to achieve. Chipotle's success, particularly in the face of macro headwinds, is a clear indication of the value consumers find in what the business offers.
Another reason to appreciate this company is its growth potential. The leadership team believes that there could be 7,000 Chipotle locations in North America one day, effectively doubling the current physical footprint. That would certainly lead to more sales and earnings over time.
Chipotle is also very profitable. In fact, its operating margin, which came in at 16.9% in Q3 (ended Sept. 30), is more than double the 8.2% the company reported in the third quarter of 2019. This is proof that there are cost advantages inherent in the business model as it scales up and increases its revenue base.
Chipotle's path to $1 trillion
I'm sure that the vast majority of investors would agree that Chipotle is a fine business. However, there are questions about whether it's a solid investment choice right now. That's because the stock trades at a price-to-earnings (P/E) ratio of 61 (as of Dec. 6). This represents a 140% premium to the broader S&P 500.
Paying a high valuation introduces a major headwind for investors hoping to achieve strong returns. It showcases the market's heightened expectations toward the company, leaving a minimal margin of safety. Should Chipotle post even the slightest quarterly miss with same-store sales or margins, for instance, the share price could drop quickly.
For the already elevated market cap to reach $1 trillion by 2040, it would need to rise at a compound annual rate of 16% over the next 16 years. For what it's worth, Chipotle's market cap has climbed at a yearly pace of almost 28% in the previous 16 years. So, this outlook would mark a notable slowdown.
To be clear, I do not believe that Chipotle will get to the $1 trillion mark in the time frame, if ever. As I just mentioned, the valuation is very stretched, making it reasonable to assume the P/E ratio will contract significantly over time, approaching the market multiple.
Moreover, Chipotle is becoming a more mature business. Revenue and profit growth should naturally start to slow as it further penetrates the U.S. market and continues to find more customers. There is simply less opportunity for expansion as a company gets larger, so the financials won't soar at anywhere near the rapid clip of the past.
There are currently 10 companies in the exclusive $1 trillion club, most of them with huge exposure to various tech-driven trends. To say that Chipotle doesn't have as much potential as these kinds of enterprises isn't a controversial take.
Investors looking to own this stock are better off waiting for a major pullback before buying.
