Take the Plunge?
How to Handle Extended Stocks
A New Leg to Chipotle’s Growth Story?
We always like to be timely in these Wealth Advisories, so today I want to write in detail about a question I’ve been asked by many subscribers during the past two weeks. It goes something like this:
“You recommended XYZ two weeks ago (in Cabot Market Letter or Cabot Top Ten Trader) and it’s up nicely since then. Is it too high to buy? Should I wait for a pullback? Help!”
Clearly, the market has been super-strong of late, soaring to new highs after the January correction, barely taking a breath along the way. And dozens of stocks have joined the party, including a bunch that have gapped up on earnings. (I really don’t remember a time when so many stocks reacted well to earnings as they did in this round of reports.)
If this applies to you, what should you do? There are a couple of options.
First and foremost, consider your overall portfolio stance. If you’re already heavily invested (whatever that means to you), you can be choosier about new buying. After all, if you miss a stock because the market is hot, no big deal—you likely have a few other stocks doing great!
However, if you’re still mainly on the sideline, it’s better to force yourself into a couple of strong situations.
Why? Because, as a growth investor, it’s imperative that you stay in gear with the market … that you respect what the evidence is telling you. Right now, the trends of the major indexes and a bunch of leading stocks are strongly up, so if you’re heavily in cash, you’re basically arguing with the market!
This advice is no different than my advice for investors who own a sudden loser (after, say, a big earnings gap lower), or are heavily invested when the market turns down. You don’t ever want to be in a position of just hoping things pull back (in today’s scenario) or bounce (if you own a loser). You want to take at least some action so you’re never too far out of synch.
Also, remember that every “system” worth its salt has a method for getting out of a trade if something goes wrong (i.e., stop-loss), but few have a method to get into a trade if it’s heading up. So, at least near the start of a market rally, it’s a good idea to push yourself to get on board a couple of leaders.
Now, that said, I don’t advise you to jump in with both feet, either—many stocks are up 15%, 20% or more during the past few weeks, especially if they’ve gapped on earnings. And plowing in here could leave you open to some sudden losses if the market retreats … which is why most people are hesitant to begin with. If you dive in today and then get clobbered during the next two weeks, you’ll lose money and, more important, confidence.
If you’re a hard-and-fast buy-on-pullbacks investor, I suggest that you look at a stock’s 10-day moving average—it’s a short-term measure, but many names that recently blasted off will find support from that line during their first pullback or two.
So generally speaking, it’s OK to buy without waiting for a pullback … but if you do, try to buy smaller-than-normal positions. How small? Anywhere from half to three-quarters your normal size—so if you usually buy $10,000 of a stock, buy $5,000 to $7,500 instead. If the stock motors higher, terrific! You’ve got a decent position. And if it does pull back, you’ve got a smaller position, which means you can give the stock more leeway than usual to gyrate and consolidate.
“OK Mike,” you might ask, “If I buy $6,000 worth of a stock and the stock declines, should I buy the other $4,000?” Ah, good question, glad you asked.
Personally, I never, never, never, never average down or buy at lower prices (at least when it comes to growth stocks—value and dividend stocks are another story). As famous trader Paul Tudor Jones used to say, “Losers average losers.” Thus, for me, no.
I would write down a loss limit after the smaller initial buy and stick with it. If a more traditional, attractive entry point forms a few weeks later, and I have a profit, then I might fill out my position.
I do think that if you form a plan ahead of time (and have the discipline to stick to that plan), you can “average in,” maybe buying half at 85 and then the other half at 80. But … and this is a big but … after that second buy, you must set a hard loss limit that keeps any loss reasonable.
As you can tell, there are a lot of ifs involved when you’re trying to get into extended stocks; it’s tricky and does carry risk. But using some common sense, you should be able to push yourself off the sideline and into a couple of new leaders without betting the farm.
However, just because the market has been very strong doesn’t mean there aren’t any stocks that are currently setting up. You might think that stocks that haven’t raced to new highs are laggards, but I think it’s way too soon to say that, considering the market re-entered a new intermediate-term uptrend just two weeks ago. Maybe three weeks from now, if a stock hasn’t gotten off its knees, it would be a bad sign, but right here, it’s too soon to dish out labels.
One, in a pristine set-up that appeared in Cabot Market Letter most recently is Chipotle Mexican Grill (CMG), which is poised to become the next McDonalds (in fact, McDonalds owned Chipotle before it was spun-off in the mid-2000s). To be honest, CMG is a bit more well known than I prefer, and its huge valuation (53 times trailing earnings!) compared to its earnings growth (20% to 25%) isn’t ideal, either.
However, the more I study CMG, the more it reminds me of Coca-Cola and General Electric back in the mid-1990s—neither company was growing that fast, but institutional investors ran the stocks up for years (to huge valuations) as they discounted what was likely steady double-digit earnings growth for years to come. Eventually, after the 1998 mini-bear market, that game ended, but it was a big advance.
I think Chipotle has much more growth potential than either of those two behemoths. Yes, it has about 1,600 locations today, but that number could double in the years ahead, and the firm is just beginning to expand (at a very slow clip) a couple of new concepts—Pizzeria Locale, which can make a custom pizza in a matter of minutes and has a couple of locations in the Denver area, and ShopHouse, which is very similar to Chipotle but for Asian fare. There’s been one location in D.C. for a while, and it’s expanding to eight within a few months.
Of course, those new concepts won’t impact the bottom line for a couple of years at least, but it doesn’t take a genius to see that if either (or both) of these concepts succeed, Chipotle will have a whole new leg to its growth story.
Anyway, right now, the firm is doing well after a slowdown last year—sales growth is (very) gradually accelerating, up 13%, 18%, 18% and 21% in the past four quarters, while earnings were up 30% in the fourth quarter—the fastest rate of growth since mid-2012. And analysts see the bottom line up about 25% both this year and next.
Lastly, the stock itself peaked near 550 in November, futzed around for a couple of months, and then dove to 480 during the market correction. But it gapped up back to 550 after announcing fourth-quarter earnings, and has traded tightly during the past three weeks. If you’re game, I think it’s buyable here, with a stop near 525. Any powerful move above 565 or so would be highly bullish.
Chief Analyst of Cabot Market Letter
And Cabot Top Ten Trader