1 Wall Street Analyst Thinks This Top Stock Could Soar 30%. Here’s Why I’m Not Convinced That It’s a Buy Right Now | The Motley Fool

Research analysts set the tone for how the investment community views a particular business. A positive report can instill confidence that can lead to favorable sentiment.

There’s one top stock that has climbed 225% just in the past five years. However, one sell-side analyst believes it could soar another 30%. That might sound promising, encouraging you to want to scoop up shares.

But here’s why I’m not convinced that this company is a buy right now.

Catalysts for the Tex-Mex chain

Christopher Carril of RBC Capital Markets has a $75 price target for Chipotle Mexican Grill (CMG -0.09%), implying 30% upside from the $57.51 price on Feb. 5. He thinks the Tex-Mex fast casual chain will benefit from some ongoing catalysts. There’s really nothing new to the story.

Chipotle has developed a very successful model, demonstrated by its ability to post consistently strong same-store sales (SSS) growth. This metric has risen in seven straight years.

Higher SSS have been partly driven by more foot traffic. Pricing power is another key factor. Management has been able to raise menu prices on multiple occasions in the past few years, which hasn’t had a negative effect on revenue growth.

Despite economic uncertainty, the business has been able to thrive. This highlights the value proposition that customers find when choosing to eat at the restaurant chain. With the prospects of an improving macro environment in the near term, perhaps Chipotle’s already impressive financial performance will get a boost.

It’s also hard to deny Chipotle’s financial strength, another area that gives RBC’s Carril confidence. Chipotle’s operating margin was a stellar 16.9% last year. That has expanded from 7.9% five years ago in 2019. There’s a proven operating leverage here, as Chipotle scales up and is able to generate better profitability.

We can’t forget about the company’s growth trajectory. Chipotle plans to open 315 to 345 new stores in 2025, which would bring its total to more than 4,000. The pace of new openings has actually been accelerating in recent years, a clear sign of the untapped demand the leadership team sees.

However, over the long term, Chipotle believes it can get to 7,000 locations just in the U.S. With increasing annual unit volume, coupled with strong store-level profitability, there is huge potential to generate significantly higher revenue and earnings down the road.

Expectations are sky-high

To see Chipotle stock rise 30% in the next 12 months wouldn’t be out of the ordinary, especially based on the positive catalysts and momentum just described working in its favor. What’s more, shares have had much better yearly performances in the recent past.

I view the situation with a more critical eye. Valuation is a very important factor that can’t be ignored when looking at a particular stock as an investment opportunity.

As of this writing, Chipotle shares trade at a price-to-earnings (P/E) ratio of 53.5. That represents a 110% premium to the overall S&P 500. The multiple hasn’t dipped below 41.9 in the last three years.

The current valuation implies near-flawless execution, and then some, for the management team over the next five to 10 years. To their credit, though, they have done just that. But it still leaves no margin of safety. Should Chipotle miss Wall Street’s estimates when it reports quarterly financial results, the stock could tank.

Investors who still appreciate this business should pay close attention to Chipotle. Practice patience, and wait until the market presents a more attractive opportunity.