Famed investor Peter Lynch is widely known for having made some his best investments while running the Fidelity Magellan Fund by simply "trying" the product.
Two famous examples Lynch gave in his best-selling book "One Up on Wall Street" were La Quinta Hotels (LQ) and Hanesbrands Inc. (HBI). Lynch was a frequent guest at La Quinta when traveling for business. With respect to Hanes, it was the famous eggshell "L'eggs" leggings that were popular in the 1980's. Both investments were homeruns for Lynch.
I used the Lynch approach when I made an investment in Chipotle Mexican Grill (CMG) three years ago when shares were trading around $200. Chipotle serves up delicious food -- fast and cheap. I visited Chipotle and saw the long lines that characterized each store during lunch. More importantly, people were not upset about waiting in such a long line. That told me that Chipotle's customers were extremely loyal.
Because Chipotle's cuisine was delicious and the portions were fair, the company had some degree of pricing power. Despite a couple of price increases during the past year, Chipotle's volume continues to grow by double digits.
The Chipotle effect has rippled through the restaurant industry. I still own CMG shares, but I'm not buying them at current prices. There's a mini-bubble going on with the new trendy, fast-casual restaurants. Shake Shack (SHAK), the trendy burger chain that recently went public and saw its share price double out of the gate. It is valued at nearly $600 million. And it only has 63 locations. I think SHAK is a great business, but a great business does not mean a great investment. Price and valuation is the bridge between a good business and a great investment.
The Habit Burger Grill (HABT) is another great restaurant company about which the market has become over-excited. With a valuation of over $250 million, HABT earned $7 million for the 39 weeks ended 9/30/2014. There are a lot of trendy burger chains out there, both private and public, and competition is fierce. But because the market is obsessed with growth stories, trendy restaurants are all the rage these days, thanks to Chipotle.
Noodles and Company (NDLS) climbed as high as $41 a share, no doubt because of investor excitement for the next Chipotle. But NDLS sunk back to $18 a share. Even that price values the company at 50x trailing earnings.
If there is one lesson the market teaches repeatedly it is that unchecked excitement surrounding a business can lead to a very painful outcome in the end. With this new generation of restaurant companies today, perhaps buying the food is a better use of your money than buying the equity.
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