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Should We Worry About Chipotle Mexican Grill, Inc.'s (NYSE:CMG) P/E Ratio?

Simply Wall St

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Chipotle Mexican Grill, Inc.'s (NYSE:CMG), to help you decide if the stock is worth further research. Based on the last twelve months, Chipotle Mexican Grill's P/E ratio is 70.55. That is equivalent to an earnings yield of about 1.4%.

See our latest analysis for Chipotle Mexican Grill

How Do You Calculate Chipotle Mexican Grill's P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Chipotle Mexican Grill:

P/E of 70.55 = $787.87 ÷ $11.17 (Based on the year to September 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

How Does Chipotle Mexican Grill's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Chipotle Mexican Grill has a significantly higher P/E than the average (22.4) P/E for companies in the hospitality industry.

NYSE:CMG Price Estimation Relative to Market, October 27th 2019

That means that the market expects Chipotle Mexican Grill will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.

Chipotle Mexican Grill's 66% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. And earnings per share have improved by 64% annually, over the last three years. So we'd absolutely expect it to have a relatively high P/E ratio. Regrettably, the longer term performance is poor, with EPS down 3.0% per year over 5 years.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

So What Does Chipotle Mexican Grill's Balance Sheet Tell Us?

Chipotle Mexican Grill has net cash of US$815m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Chipotle Mexican Grill's P/E Ratio

Chipotle Mexican Grill's P/E is 70.5 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. The excess cash it carries is the gravy on top its fast EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings).

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Chipotle Mexican Grill may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.