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Why Warren Buffett Would Love Chipotle

Warren Buffett, arguably the greatest investor of all time, advocates following timeless principles for stock market success. Probably the single most important characteristic he looks for in a potential investment is a competitive advantage, or moat.

Chipotle Mexican Grill (NYSE: CMG) fits the bill here, as it has created and dominated an entirely new segment of the restaurant industry. The fast-casual chain has found remarkable success because of its brand recognition, customer value proposition, and pricing power, all of which support the company's competitive advantage.

As a result, the stock has been a real moneymaker, soaring nearly eightfold over the past decade. Even with the novel coronavirus negatively impacting 2020 thus far, Chipotle stock is still up over 35% year to date. Berkshire Hathaway, the conglomerate headed by Buffett, is currently sitting on a $137 billion cash pile (as of March 31). Although he has claimed he doesn't eat Mexican food, Buffett's familiarity with the restaurant industry, his massive cash position, and the attractiveness of the business are all the necessary ingredients for why I think he'd love Chipotle.

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Image source: Getty Images.

It's all about the brand

One of Chipotle's key strategies is to make its brand more visible and loved. The company was a pioneer of the fast-casual dining segment, which is now a highly competitive space with myriad options for consumers to choose from. The company has achieved such a dominant position that other fast-casual restaurants are often referred to as the "Chipotle of [name your cuisine]." Securing top-of-mind brand loyalty from consumers cannot be understated and will benefit the business for many years to come.

In the wake of the 2015 E. coli outbreak Chipotle has implemented enhanced safety procedures in its restaurants and supply chain (now quite relevant in the current environment as well). Such aggressive measures eventually won back customers' trust. After a drop in 2016, sales and profits have risen every year since -- Chipotle overcame adversity and is now thriving again, something Buffett would appreciate.

Customer value proposition

Chipotle offers customers a delightful experience with its focus on simplicity, quality, and affordability. To drive customer loyalty, the company launched its rewards program in 2019. As of the first quarter of 2020, the program had 11.5 million enrolled members.

COVID-19 put Chipotle's digital offerings to the test. Luckily, the company had already invested in improving its kitchen layout to speed up the service for delivery and pickup orders. Digital orders hit $372 million during the first quarter, up 81% year over year. That metric will likely be even higher for the quarter ended June 30 as that period encompassed lockdowns across most of the country. Chipotle is proving that it can be a winner in the post-pandemic world.

Buffett prefers to own companies that delight their customers and being able to do so is especially important in the restaurant business, where consumer tastes and preferences are ever-changing.

Pricing power

Chipotle has also demonstrated over the years that it can consistently raise prices without hurting revenue. During 2017 and early 2018, prices for various menu items rose 5% to 7%. Certain menu items increased further last year, but there was seemingly no negative effect on the top line, which grew at a compound annual rate of 13% from 2016 to 2019.

Pricing power -- another trait Buffett likes to see in any business -- is wonderful for investors, because it shows that customers truly value the product they're buying. I expect Chipotle to continue adjusting menu prices to protect its profitability as food costs rise.

With a trailing price-to-earnings ratio of 95, Chipotle stock is by no means cheap, according to traditional valuation metrics. Rapid growth over the last few years, coupled with the company's resilience during the ongoing pandemic, has driven up the stock price to a level at which Buffett would likely feel uncomfortable buying. Regardless, the company's strong balance sheet, significant competitive advantages, and proven business model should attract investors' attention.

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Neil Patel has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and Chipotle Mexican Grill and recommends the following options: long January 2021 $200 calls on Berkshire Hathaway (B shares), short January 2021 $200 puts on Berkshire Hathaway (B shares), and short September 2020 $200 calls on Berkshire Hathaway (B shares). 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.

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