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Chipotle and your Calculator: a lot of Burritos to Justify That Stock Price

Chipotle's (CMG) meteoric rise since hitting the public markets in 2006 continues to attract, well, detractors - particularly when it has a trailing PE of almost 60. That pushes Chipotle’s market cap to an improbably $12 billion or so.

Chipotle Mexican Grill Stock Chart

Chipotle Mexican Grill Stock Chart by YCharts

Wall Street Journal columnist Jack Hough is the latest to cast a gimlet eye on Chipotle.

Hough, using a methodology from McKinsey partner Tim Koller, examines Chipotle by projecting out its stock price a decade from now, assuming a 10% annual growth rate, and then figuring out what its earnings would have to be if the stock winds up with a PE of 15 - the historic average for stocks.

He calculates that Chipotle would need earnings of about $69 a share, or about a 26% compound annual rate of earnings growth over the coming decade to match his projections. Wall Street expects the restaurant chain to earn $8.70 this year.

Assuming some sort of comparable gain, Chipotle's revenue would be about $20 billion a decade or so from now. McDonald's (MCD) revenue was about $27 billion in 2011 and Starbucks (SBUX) was about $12 billion. For some investors, the scenario that puts Chipotle in the same revenue boat as these other giants - too tough a feat, so too expensive a stock particularly given its current valuation.

Even on a forward basis, Chipotle's PE is considerably above Starbucks at 22.7 and McDonald's at 15.3. True, Chipotle's revenue growth is also superior to these two companies.

Chipotle Mexican Grill Revenue Growth Chart

Chipotle Mexican Grill Revenue Growth Chart by YCharts

And yes, its net income has also shot up like a rocket alongside its stock price.

Chipotle Mexican Grill Net Income TTM Chart

Chipotle Mexican Grill Net Income TTM Chart by YCharts

A closer look into the data shows that Chipotle's forward PE is about 1.6 times its revenue growth. By that measure, it's equal to that of McDonald's and a little higher than Starbucks at 1.4 times.

Compared to net income growth, Chipotle's PE is 1.8 times the 20% gain it enjoyed in 2011, which is less than Starbuck's level of 2.2 times its net income growth and slightly less than McDonald's valuation of 1.4 times net income growth.

Hough noted that Chipotle would have to enjoy a compound rate of growth of about 26% over the next nine years to get the earnings support for the higher stock price at a reasonable valuation. Well, it's had a 25% CAGR for the past five years, but as they say in the investment business, past performance is no guarantee of future return, and nothing grows like a weed forever.

Michael McHugh is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings, stock screener and portfolio strategies.

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