A stock split doesn't always lead to a big rally. Chipotle Mexican Grill (NYSE: CMG) recently deployed a massive 50-for-1 stock split, but its shares have been going in the opposite direction of late. On June 27, the stock began trading on a post-split basis at just over $62. But last week, its shares dipped below $50.
Since then, the company has reported its latest earnings numbers, which remained strong. But despite this, the stock has been struggling. Is this just part of the market's recent pullback? Could this be a great time to buy the stock, or is there more trouble ahead for Chipotle?
The company's earnings looked good, but they came with a caveat
Chipotle's business has performed incredibly well, despite inflation. The company reported earnings in July, and comparable-sales growth was impressive, coming in at 11% for the period ending June 30. It was especially impressive that transactions were up by 8%. Greater traffic drove the strong numbers, as opposed to price increases, as has been the case for many other restaurant chains. The company has used price hikes to offset rising costs, and its margins have expanded as a result.
But the company hinted at some weakness ahead. Its restaurant operating margins were 28.9% this past quarter, an improvement from 27.5% a year ago. Next quarter, however, the company sees that shrinking to 25%, which suggests costs and wages are rising faster than price increases. For investors, that's a concerning sign as worsening margins will put pressure on the bottom line, which could make this already expensive stock look even pricier in the near future.
Chipotle's high valuation means investors expect perfection
Producing a strong quarter isn't enough to satisfy Chipotle investors because investors expect a lot. This is why the company has a high earnings multiple, which prices in a lot of future growth. While Chipotle's share price may have come down due to its stock split, its valuation remains high with respect to profitability.
The food stock is trading at just under 50 times trailing earnings, but it was far higher before this recent sell-off. The problem with such a high valuation is that expectations are also high. If the company fails to come through on guidance, as well as earnings, it can lead to a correction in the stock price.
Chipotle's business is generating good growth numbers, but that may not be enough for the stock to bounce back in the months and weeks ahead. It has a consensus analyst price target of more than $60, but analysts have been lowering their price targets in light of the recent developments as there is more bearishness around Chipotle's stock these days.
Should you buy Chipotle's stock?
Chipotle's stock is up more than 200% in the past five years and has proven to be an excellent investment. But at such a high premium, even with this recent sell-off, there's not a big margin of safety for investors should future quarters be underwhelming.
Unless you're prepared to hang on to the stock for multiple years, you may be better off holding off on buying shares of Chipotle. There are plenty of other good growth stocks to consider, instead. Its high valuation combined with concerns that its margins may be coming under pressure could make it difficult for Chipotle's stock to rally higher in the near term.
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David Jagielski 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.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
