Bill Ackman Reduced Chipotle Stock, Fundamentals Still Sound

Key Points

• Bill Ackman's fund reduced its stake in Chipotle stock, spooking some investors in all the wrong ways.
• Like a risk-management practice, this reduction has nothing to do with the company's underlying fundamentals.
• Despite outperforming its peers, analysts see double-digit EPS growth and upside left in Chipotle.

Investors may feel uneasy seeing one of Wall Street’s top value investors, Bill Ackman, sell a stock. Reducing or even bailing out of a company could send many wrong signals to the market, so investors can follow a rule of thumb. When investors buy a stock, it is only to make money. However, selling could be a decision rooted in a dozen different reasons.

Whether it is for tax-loss harvesting, a practice investors use to unload losing positions at the end of the year to offset the capital gains they – hopefully – had during the year, or whether it is to rotate out of a sector or company weighing, selling can happen due to more than just profit taking.

Bill Ackman reduced his holdings in Chipotle Mexican Grill Inc. NYSE: CMG by 9.8% in the past quarter. However, it is still Pershing Square’s (Ackman’s fund) largest holding. Deciding to keep up to $2.1 billion in Chipotle stock, roughly 20% of his fund, speaks more than the recent reduction, which may not imply a bearish view of the company.

It’s Called Risk Management

Shares of Chipotle rallied by as much as 53.5% over the past 12 months, leaving the broader S&P 500 behind by roughly 26.2%. Even peers in the consumer discretionary sector had difficulty keeping up with Chipotle, as McDonald’s Co. NYSE: MCD and Starbucks Co. NASDAQ: SBUX delivered a respective 7.2% and 27.3% decline during the year.

Because of this outperformance, the weight of Chipotle stock in Ackman’s portfolio became too large. The best practice in this situation is to block intrusive thoughts leading to greed, just like a hot poker player should take some chips off the table and cool off.

Investors should be aware of this tendency to cut winners occasionally, as overstaying in a winning stock could lead to nightmare-like outcomes. Knowing this, Chipotle is far from a stock that Main Street should avoid, especially in today’s economic environment.

Chipotle’s Growth Is Nothing to Walk Away From

This isn’t going to be just any other cycle; the U.S. economy is giving economists something new to worry about. Gross domestic product (GDP), also known as the size of the economy, pushed out a mere 1.6% growth in the past quarter. 

The economy is falling into stagflation because inflation remained above 3%, nearly twice as high as GDP growth. Stagflation is defined as little to no economic growth and high inflation. Portfolios need a new strategy to beat this destructive cycle.

Two things should be at the top of portfolio managers and retail investors' minds: steady and predictable growth (ideally above average). This is where Chipotle comes in to save the day, as Wall Street analysts expect to see 20.2% earnings per share (EPS) growth in the next 12 months.

This growth rate, which is definitely above the long-term GDP growth rate, is also above McDonald’s 8.3% EPS projections and the 12.9% analysts see out of Starbucks this year. Because of this above-average growth gap, markets are willing to bid Chipotle stock to 98% of its 52-week high, but that’s not all.

Compared to the retail sector’s 23.6x P/E multiple, Chipotle’s 67.0x valuation calls for a premium of 183% today. Stocks typically trade near their 52-week highs and at higher P/E ratios for a good reason, and Chipotle’s EPS growth projections could be one of them.

Wall Street’s Take

Chipotle’s financials show investors another reason to stick with this compounder. Operating at 40.9% gross margins lets management keep more capital from each dollar sold, reflected in the company’s 15% average return on invested capital (ROIC) rates over the past 5 years.

Because annual stock price performance follows the long-run ROIC rate, investors can expect their investment to rise by this percentage. All the technical and fundamental factors make Chipotle a stock to keep portfolios above today’s stagflation. 

Even bearish traders aren’t looking to slow the stock down and keep it from making new all-time highs. Over the past month, Chipotle’s short interest declined by 9.7%, giving bulls the open field to squeeze the potential in the company’s fundamentals.