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When Premium Valuation Kills: The Chipotle Effect
I'll start by saying that I love Chipotle, I go there every Friday and I'm excited about it every time. So for me, watching CMG shares get crushed by more than 20% on Friday is a little bit like sharing a tearful goodbye with a loved one, or losing your longtime soul-mate to your best friend. But what happened here is nothing new, and it's been an increasingly prevalent trend in this market. CMG is still a fantastic company, and the dramatic selloff isn't necessarily its own fault. CMG's main problem is that it was a victim of premium valuation after trouncing Street expectations quarter after quarter and taking the fast food world by storm. It had a forward P/E multiple of 36 before Q2 earnings.
Stocks with hefty growth premiums are often the ones to get hit the hardest when people find out that breakneck acceleration is winding down. In this economic rough patch that sees: 1) weakening consumer strength, 2) sheer terror in Europe; and 3) record high crop prices it's so easy for high-growth stocks to make that one small (but in the market's eyes fatal) misstep. In Chipotle's case it fell victim to factors #1 and #3.
The thing is, CMG reported earnings of $2.56, which blew away consensus by $0.26. The revenue result of $690.9 million (up 20.9% y/y) versus the $706.29 million consensus was the straw that broke the camel's back. Meanwhile, costs of the company's high-end ingredients are expected to be an issue moving forward amid the drought. All of a sudden that 36 P/E is now 28, which is still actually high and priced for strong growth. But when those premiums get erased the stock price damage can be massive.
We saw a similar effect on Friday in Intuitive Surgical (ISRG) which is a still a ground-breaking and wonderful Company. In fact, it blew away expectations in its second quarter by selling 150 of its da Vinci machines versus an expected 143. That led to a $0.18 beat on EPS versus consensus and raised revenue guidance calling for 20-23% growth. But the Street smelled just a whiff of weakness in the results, with European sales edging down, and with growth of non-critical procedures decelerating just a little. Consequentially, the short sellers pounced on the Company's forward P/E of 32. The stock is down 8%, as the P/E has been dialed down to 28. (For the record I still think ISRG is a fantastic stock and well worth holding long term as it's literally the cutting edge of medical technology).
Beware anything with a high P/E, folks. Just about any company under the sun can see softness in Europe, or margin compression from food prices, not to mention the retracement of the entire global economy. Even the littlest trip-up can get those momentum growth stocks burned, and it's just so easy to trip up right now. And then it's bye-bye P/E premiums.
CMG - 6 month
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