Value a Company on Its Attributes

 | Mar 27, 2013 | 1:30 PM EDT
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How much would you pay to own a business that since 2004 had grown its revenue from over $400 million to nearly $3 billion? I would also note that 2008 and 2009 saw revenue grow by double-digit percentage points. This company has been profitable since its public coming-out party. Profits have grown every single year, from less than $10 million in 2004 to nearly $300 million. This growth was accomplished without the use of any debt.

You might say those numbers are in the past and that an investment should be based on future prospects. I would agree 100% on that. I also would emphasize that it costs this particular company an average of $800,000 to add another production facility. After 12 months of production, each facility is adding about $2 million in sales and operating cash flow of about $600,000, for a return on investment of 70% in year one. Most importantly, the current demand factors will allow this company to continue adding production facilities at a rate where they could double in five to seven years. Twenty years from now, this company could triple the number of production facilities.

So what would you pay? Let's take a simple approach and simply value one production facility. How much would you pay to get a business that generates $2 million in annual sales and $570 million in operating cash flow? I'll assume no growth in sales. The maintenance capital expense is very minimal for this business -- every several years or so you may have to update your equipment and spend several million dollars. If you say 10x operating cash flow, you are paying $5.7 million. Call that a 10% return, which I think anyone will take. This is particularly true if you know that cash flows may grow modestly, but for the long-term you can expect a 10% return, perhaps 9%, maybe 12%.

So if you would pay $5.7 million, then this company's 1,180 facilities are worth $6.7 billion. But if you own the actual company, you get the rights to add units at a cost of $800,000. On the flip side, the company has to incur corporate costs that would not exist if you just owned a single unit of production. Still, the growth potential is huge, so perhaps you pay $7 to $8 billion.

The company I'm referring to is Chiptole Mexican Grill (CMG). Its current market cap is $10 billion. So why am I touting it when I suggest it is worth $8 billion against a market cap of $10 billion? Because when Chipotle falls to less than $8 billion, the price-to-earnings ratio is still near 30x. And many value investors won't touch a company that trades for over 15x earnings.

I'm a deep-value investor, but value is not measured merely by statistical ratios. Tremendous value resides in the qualitative aspect of the business. So when Chipotle shares took a temporary dip below $250, I bought. I'll do so again if I get the opportunity. Chipotle is a good example of why valuing a business the same as all other businesses can be a mistake. Think about the company and its attributes, not merely a current assigned ratio.

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