The historical way to determine whether a stock is a good buy or not is the ratio between its current stock price and its earnings per share. I am of course talking about the classic PE ratio. You may roll your eyes and even laugh out loud. After all, there are many ridiculous companies like Twitter that don’t give a damn about PE because they’re worth dozens of billions of dollars, and they even haven’t turned the red cent in profit.
I can understand if you’re laughing reading this blog post, but the reality is that if you extend the timeline far back enough, PE always comes back and PE always rules. You might not believe it now but if there’s a market correction, guess what? It’s all going to revolve around PE. The stock you buy, stay in, and leave will all depend on price per earnings ratio.
It was true back then, is true now, and will continue to be true long into the future. Why? People make rational decisions. People use common sense. You wouldn’t buy an item if it’s priced so far outstrips its inherent value that it doesn’t make any sense. The bottom line for all stocks as far as the inherent value is concerned is how much money it earns. There might be some temporary fad stocks like Twitter, but if you look at the timeline of the stock market, it’s all about value and earnings. Does a company make a profit or not? That is the bottom line.
With that out of the way, with the PE ratio of 47, Chipotle (NYSE:CMG)might be a tad bit overvalued. Don’t get me wrong, there’s a lot to recommend about this Mexican restaurant chain based in Colorado. It really revolutionized the restaurant space with its emphasis on fresh, organic food. With that aside, however, 47 PE is very hard to sustain considering the fact that other restaurant chains don’t trade anywhere near that level.
What would sustain this price, however, is growth. If the company’s sales growth is high enough, this would be sustainable. Unfortunately, the stock stumbled because it hasn’t been able to keep up with that growth trajectory. Moreover, analysts’ expectations are another factor. All told, its 47 PE ratio might make this stock overvalued and might make it a reasonable short sale candidate.