To say the trajectory of the Chipotle (CMG) stock price has been a roller coaster is to do roller coasters a disservice. Roller coasters build up nearly all their momentum on their preliminary ascent and then rely on inertia for much of the remaining journey. Chipotle? The stock did it the hard way...gaining momentum steadily over years, abruptly losing it in PR debacle after PR debacle, and then speeding to a new high and low, again and again. In this Case Study we examine the various stages of Chipotle’s growth, the stumbling blocks encountered as it revolutionized the fast-casual food industry, and the many ways the stock was influenced by human behavior.
Nosebleed Highs and Abyssal Lows
There was a time when the moat between fast food and sit-down dining was oceanic. The dining expectations were entirely dissimilar and the rigid business models created no chance for confusion. So in 1993, when Steve Ells introduced an alternative at a price point of roughly $8 or $10, many assumed it wouldn’t work. It was too expensive to be considered fast food but too casual to be sit-down, service-oriented dining. Instead, by 2006 (and with an assist from McDonald’s in the interim), the company had grown to over 500 locations. By offering customers choice and by focusing on quality ingredients to a fault, Ells created a business model that combined efficiency and scalability.
But that’s only part of the story
Knowing nothing about what’s being shown in the table below, one can nonetheless discern a lot of peaks and valleys. This is CMG’s stock price relative to the H-Factor. The H-Factor represents the human behavior biases incorporated in a stock that causes it to be mispriced. It’s a risk that investors are unaware of, which erodes alpha, and they don’t get compensated for taking. When casually observing the H-Factor in action below, it becomes clear that Chipotle is one of our “busier” scores, particularly after 2015. But then, that is exactly the strength of the H-Factor methodology. You see, for a comparatively volatile stock such as CMG, it’s natural for the H-Factor to rise and fall as well. The key point to remember is that the H-Factor Score is the risk a stock price won’t support its earnings—it’s not a simple ‘buy’ or ‘sell’ indicator but, rather, a probabilistic approach to risk. High stock prices may be perfectly justifiable if the company can meet the implied earning potential.
In Chipotle’s case, we see a combination of exogenous factors and unobjective human reasoning creating a perfect storm of uncertainty. Setting the stage in the early 2010s, the H-Factor Score remained very low in general and it never meaningfully breached 50%. Through this period, CMG’s stock price also drove higher. Momentum may’ve overheated the stock in late 2012 when both the H-Factor and stock price rose in tandem but, for almost two years afterward, an inverse correlation between the two is noticeable.
H-Factor vs. Chipotle (CMG) Price
Price Data: Provided by Nasdaq as of June 1, 2020 H-Factor Data: Provided by New Age Alpha as of June 1, 2020. The historical H-Factor Information cited above is being provided for illustrative purposes only and should not be construed as providing investment advice or as a recommendation to buy or sell any particular security.
In 2015, however, the wild ride truly began. In August of that year and continuing through July 2018, Chipotle experienced a series of disastrous foodborne illness debacles. These are the types of events—unpredictable, uncapturable by standard metrics—where traditional risk analysis would’ve been useless. A stock’s Beta can’t predict how a firm’s PR response will be seen by the general public. Its trailing ROE will have exactly zero insight into the asset burn associated with image repair and marketing.
Obfuscating matters further with another unexpected twist, Chipotle also experienced a data breach in early 2017 that impacted most of its restaurants. The malware stole sensitive data from customers’ credit cards for over three weeks prior to discovery and the admission was one of the factors knocking the stock price off its rebound.
By mid-2017, with Chipotle becoming fodder for jokes on late night talk shows, pundits were making clickbait predictions based on nothing more than gut impulse. Management was under fire and some even questioned if the company would survive.
We believe a true probabilistic view of human behavior risk would have been best attained via the H-Factor methodology. Referring to the graph once more, one can trace the rise and fall of the respective metrics. In early 2017, just as those talking heads were questioning the stock’s viability, the H-Factor dropped precipitously. Immediately thereafter, the stock price rose. That didn’t last long, however, and the stock price lost its footing just as the H-Factor sounded the alarms. Then, moving in fits and spurts in late 2018 and 2019, CMG’s price recovered. And over that period of rising stock price (1/1/19 to 5/30/20), the H-Factor averaged approximately 30% and never breached 60%. While unexpected calamities like those CMG experienced can't be anticipated, the H-Factor provided a means to measure the human behavior impacting the stock’s price.
Price Data: Provided by Bloomberg as of June 1, 2020 H-Factor Data: Provided by New Age Alpha as of June 1, 2020 The historical H-Factor Information cited above is being provided for illustrative purposes only and should not be construed as providing investment advice or as a recommendation to buy or sell any particular security.
How does this ride end?
What main attribute do Chipotle and New Age Alpha both share? The design. Chipotle’s culinary customization ability made it unique and this design has since been applied to all areas of dining, from Indikitch (Indian) to GRK (Greek). Similarly, NAA isn’t specifically a value investor or a private equity shop. It’s the design, the H-Factor methodology that—unlike any other asset managers’ processes—focuses solely on idiosyncratic human risk.
Why is this similarity important? Because we’re not about to deviate from our design and start making forward-looking proclamations like so many other mangers. The market gyrations through the first half of 2020 have been historic and there’s no reason to expect they will wane when so much socio-economic strife remains unresolved. Therefore, it would be doubly dangerous to make any predictions regarding a stock as turbulent as CMG. Further, the H-Factor isn’t intended to predict the future in the first place—no one can predict the future and we at NAA are the first to admit that. That’s precisely why it’s imperative to trust the data and strip away human behavior biases.
People—and investors in particular—can’t resist the allure of a roller coaster. It’s a source of excitement not unlike the thrill of winning big on slots. And as the nation enters the summer months and attempts at reopening the economy are made, we applaud those with the courage to board those amusement park attractions. When it comes to money, however, in the form of business and financial innovations, it’s better to trust the design.
Currently, the H-Factor score for Chipotle is at an all-time low even as its price is at an all-time high, which is astounding. In terms of forward outlook, however, our CIO, Julian Koski, is fond of saying, “What are you going to do with this information? The rest is up to you.”
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The above statements are not an endorsement of any company or a recommendation to buy, sell or hold any security. Past performance is not a guarantee of future results. These statements and views are for informational purposes only and do not represent actual portfolio results, but rather it is intended to show the application of the H-Factor to an actual security. The views stated herein are only current through the date stated and are subject to change at any time based on market or other conditions and New Age Alpha disclaims any responsibility to update such views. At the time of this publication, New Age Alpha owns CMG in one or more of its funds but it did not own it for the entire period stated herein. New Age Alpha typically holds securities in its portfolio only if it becomes part of the established universe of eligible securities that are part of each specific investment strategy (e.g. the S&P 500®). It is important to note that there can be no guarantee that the application of the H-Factor to investment portfolios or certain stock or securities can produce profitable results. For full disclosure, click here.
June 29, 2020