Like clockwork, Chipotle Mexican Grill (CMG 3.87%) once again beat Wall Street expectations. For the three-month period that ended March 31, the company reported revenue of $2.7 billion (up 14.1% year over year) and diluted earnings per share of $13.01 (up 23.9%). Shares moved higher following the news, and they are up 39% so far in 2024.
The booming restaurant stock has been a massive winner for shareholders in recent years. It has attractive qualities that any investor would love. Even the legendary Warren Buffett might appreciate what Chipotle is doing.
Asking customers to pay more
From a macro perspective, the past few years have been some of the most unusual in recent memory. Inflation has been a big topic. Even today, prices across the economy aren't coming back down toward the Federal Reserve's target of 2%.
Some companies might struggle with this reality -- but not Chipotle. It has actually proven just how great it is. In order to combat inflationary pressures, whether it's for food, paper products, or labor, the business has been successful at raising its menu prices on numerous occasions in the past couple of years. The most recent price hike happened last October.
You'd think this would discourage people from eating at Chipotle, and they'd shift their spending to more affordable options. That hasn't been the case, though. Transaction counts, a measure of traffic at its restaurants, were up in 2023. And in the first quarter, it was the same story. Additionally, with the strong gains in both revenue and earnings, it's clear that Chipotle's pricing strategy is working. Same-store sales also rose 7% last quarter.
What's even more impressive is that the company is posting these types of results in an intensely competitive sector of the economy. People have almost unlimited eating options. Yet even as menu prices increase, Chipotle keeps winning over hungry customers.
NYSE: CMG
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Buffett's hesitation
Warren Buffett, who has built one of the best investing track records ever by leading Berkshire Hathaway, knows what makes a business special. "The single-most important decision in evaluating a business is pricing power," he once said. "If you've got the power to raise prices without losing business to a competitor, you've got a very good business."
Based on those words, Chipotle is a company that the Oracle of Omaha could certainly appreciate. It's in Buffett's circle of competence as well, given that his conglomerate previously owned Restaurant Brands International and currently owns Dairy Queen.
But if Chipotle fits one of Buffett's most critical criteria -- pricing power -- then why doesn't he own the business? It might boil down to one obvious factor: Chipotle is way too expensive right now. In the past five years, shares have skyrocketed 367%. By comparison, the S&P 500, with dividends included, produced a total return of 88%. Chipotle's monumental performance pushed management to announce a 50-for-1 stock split.
As of this writing, the shares trade at a price-to-earnings (P/E) ratio of 71. That indicates extreme levels of optimism surrounding Chipotle and its prospects. In other words, there is no margin of safety.
Even when you factor in management's goal of doubling the store count in North America over the long term, the shares are still pricey. That valuation multiple is likely to come down over time, creating a major headwind for investors.
Buffett has shown a willingness to pay for high-quality businesses only when the valuation is compelling. Berkshire first bought shares in Apple in the first quarter of 2016. At that time, the iPhone maker's stock traded at a P/E multiple of around 11. Unless Chipotle's valuation contracts significantly, the stock is unlikely ever to find its way into Berkshire's portfolio.
