The price paid is a critical component of the investment

I remember very well. It was two years ago. While we were shareholders of McDonald’s for some time, one of our clients asked me this question: “Why are you investing in McDonald’s? The title of Chipotle would it not more attractive in the long term? ”

The question was very valid. The chain Chipotle Mexican Grill knew a hit in the US since its IPO and spin-off … McDonald’s in 2006. Now, as Starbucks has shown, a restaurant chain that is successful in its infancy and who managed to build a good reputation with the public offers enormous growth potential in a market as huge as the United States. When you think that only the state of California alone is more populous than Canada, we realize this potential: years and years to open new restaurants throughout the country.

Moreover, even today, it seems clear that consumers, albeit still in a hurry, looking increasingly healthy foods while the traditional fast food at McDonald’s is declining. Chipotle, with its fresh food, meat, vegetables and tortillas, seemed therefore meet growing demand in the US population. And that’s not counting the international potential. Besides, I had myself visited a Chipotle restaurant with my family in Florida and had been very impressed.

So I looked at Chipotle situation more closely. That was two years ago, at the beginning of 2014. The stock was trading at around $ 550. Profits per share were higher at $ 10.36 per share in 2013 and they were heading merrily towards $ 14 in 2014. The title was therefore valued at about 39 times expected profits.

A good way to measure this level of evaluation was to compare it to a title that I knew well as we had in the portfolio: McDonald’s. But at the same time, the title of McDonald’s was worth about $ 95. In fact, the stock was trading between $ 90 and $ 100 since 2012. At that price, it was trading at 17 times its 2013 profits and less than 20.0 times earnings of $ 4.82 per share that chain would achieve in 2014. I must say that all was not well for McDonald’s at the time. Its same-store sales were declining, she knew the difficulties in Europe due to the economic crisis that raged (did you know that McDonald’s pulls over Europe revenues in North America?) And its results were strongly affected by the strength of the US dollar.

Two years later, which of the two titles outperformed the stock market?

McDonald’s, by far. The latter has a return of over 32%. With dividends, the total return approaching 40%. As for Chipotle, the stock is trading today at around $ 467, 15% lower than two years ago (and the company does not pay dividends).

The quality of a company and its growth potential are not the only elements to evaluate in analyzing a stock title. The price you must pay for these items is even more important. There are two years, everyone could get a good idea of ​​the potential of Chipotle. But the price-earnings ratio at which the security was negotiating was very high: its assessment largely reflected its strong growth potential. However, the assessment as McDonald’s seemed much more reasonable and, obviously, the expectations of investors about growth opportunities were much lower.

The Exchange is somehow a pari-mutuel system, as in horse racing. Unless neophytes, most bettors on horse racing know the horses running, their pedigree. If you bet on the horse that heavily favored hand, your earnings will be relatively small if he wins. By cons, if you bet on an unknown horse or whose chances of winning are low and should win, your winnings will be substantial. There are two years, everyone saw Chipotle as a thoroughbred winner while the title McDonald’s was seen as a horse nearing retirement.

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