A Better Way to Trade in 2017
Welcome to 2017.
If you’re anything like me, you’re glad the holidays are over. Don’t get me wrong, taking a break from work and spending quality time with family is a good and necessary thing.
But now it’s time to get back to business. Time to look forward. Time to plan for 2017 and beyond and navigate the challenges the market will likely bring.
With this in mind, I recently came across an interesting trade that my colleague Jared Levy, Chief Investment Strategist of Profit Amplifier, shared with his readers…
Our Expert is Starting the New Year With a Familiar Trade
If you’ve been trading stocks for a while, then it’s very likely that you’ve developed certain “go-to” trades. These are the trades that, for some reason or other, you keep coming back to because they’re money-makers for you. Maybe you’ve been successful at determining when the stock is under or over-valued, you know how the market typically reacts to the company’s earnings reports, etc.
For options trading expert Jared Levy, fast-casual restaurant chain Chipotle Mexican Grill (NYSE: CMG) has long been one of his favorite “go-to” trades.
“Chipotle has been on my radar ever since it first went public back in 2006, and I have successfully called many of its major rallies and sell-offs throughout my career. It’s one company I know very well.”
Chipotle’s unique, affordable Mexican-themed casual dining with its non-GMO ingredients and “responsibly-raised” animal protein were a massive hit with customers. Founded in 1993, the company has grown to 2,124 stores, while the stock achieved rich valuations as it quickly grew its business. For the longest time, it seemed like the company could do no wrong according to Wall Street.
But the love affair came to a screeching halt after outbreaks of E. Coli and other food-borne illnesses plagued several Chipotle locations. The U.S. Centers for Disease Control (CDC) identified the later bacteria findings as rare strains of E. Coli. But perhaps the scariest part about the Chipotle outbreak was that the CDC and Food and Drug Administration (FDA) could not determine the root cause.
Ever since, the company has been working frantically to restore its reputation and bring back sales. But the aftermath has been devastating for Chipotle’s balance sheet.
“In the second quarter, Chipotle’s revenue fell 16.6% year over year, while comparable restaurant sales dropped 23.6%. Increased costs, including those associated with new food safety practices and aggressive marketing strategies, resulted in earnings per share (EPS) plummeting more than 80%.
The company fared no better in the third quarter. Revenues continued to fall another 14.8% (year over year) in Q3, while earnings tumbled 94.1% in the same period. Same-store sales were down nearly 22% year over year.
All in all, profit margins were slashed to 12.5% in the first nine months of the year from 27.9% during the same period in 2015.
Chipotle also missed analyst estimates by a country mile, reporting third-quarter EPS of $0.27 versus a consensus estimate of $1.59. Revenue of $1 billion for the quarter also fell short of expectations for $1.09 billion.”
As Jared points out, with such dismal numbers you’d think management would do whatever it took to get costs in line and get the brand back on its feet. But shares continue to drift lower. Based on Jared’s latest analysis, management’s actions have fallen well short and we could see Chipotle’s stock price decline much further from current levels.
Even After the Bloodletting, CMG is Still Overvalued
Instead of cutting costs and working to bring back customers, Chipotle is instead firing back with continued expansion, unsuccessful marketing videos and diversification into different kinds of food. Recent management shakeups haven’t helped, either.
Jared thinks there are likely more big changes to come. Activist hedge fund manager Bill Ackman, who disclosed a 9.9% stake in the company back in September, recently negotiated a deal to add four new members to Chipotle’s eight-person board of directors — two of his choosing, and two chosen by the board.
While this may be good in the long term, Jared worries it will cost the company time, money and sales in the short term. Four new faces and an activist investor breathing down its neck may be too many chefs in the kitchen.
Here’s more analysis from Jared:
“From there, the challenge only gets steeper. For 2017, management said they were expecting a high single-digit increase in same-store sales, and diluted earnings of $10 per share.
Analysts seem to have a slightly more conservative outlook on the stock. Bloomberg currently shows a consensus earnings estimate of $9.12 per share for 2017. In other words, analysts are expecting Chipotle to increase earnings 525% in the coming year — miraculous by any standards.
I’m highly skeptical Chipotle will be able to jump that hurdle.
Even in its glory days (between 2008 and 2014), the company averaged 30.4% EPS growth annually. Its best year was 2009, when earnings grew nearly 45%.
But, for the sake of argument, let’s assume Chipotle actually manages this magical 525% earnings growth. Let’s also say that, from there, Chipotle has another stellar year and grows earnings at its old average of 30.4% to $11.90 per share in 2018.
Based on EPS of $11.90 and an industry average price-to-earnings (P/E) ratio of 28, shares would have a price tag of only $333 — still more than 10% below current prices around $380.”
Bottom line, Jared thinks the recent broad market rally has pushed this stock’s price way too high. While Chipotle’s fundamentals have only gotten worse over the past quarter, its forward P/E ratio has skyrocketed to a truly mind-boggling 268 — the priciest CMG has been since it began trading publically.
Jared thinks shares are likely to return to recent lows of $352 — a 7.4% fall from recent prices. However, for this trade, Jared and his subscribers at Profit Amplifier don’t need to see shares fall that far to generate a sizeable profit. By using put options, they can generate a significant gain from a much smaller move — just 2.6% below recent prices. If the stock hits this level, it could net a 25% gain.
As we’ve pointed out many times before, the beauty of Jared’s options strategy is that you can bet against stocks like Chipotle and amplify your potential gains without having to risk too much capital. In today’s environment, we think it’s more important than ever for investors to be willing to try new strategies like options. If you’d like to learn more about Jared’s impressive track record and how to use simple options strategies yourself, visit this link.