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2 Lessons From This Stock’s Remarkable Turnaround

While I have had some success in the stock market so far, I have also made my fair share of mistakes. I want to share one particular investment that taught me a few invaluable lessons about investing.

Stock background

In late 2015, I bought shares of fast-casual chain, Chipotle Mexican Grill, Inc. (NYSE: CMG) for US$564 per share. At that time, Chipotle was a stock market darling with same-store sales growing at a mid-single-digit pace and with the company planning to add more than 100 restaurants to its business in 2016.

However, things soon took an unexpected twist. In November 2015, 55 people in 11 states were hit by an Escherichia coli (E-coli) outbreak that originated from Chipotle. A few months later a sick employee passed a Norovirus to another group of customers as things continued to get worse for Chipotle.

Unsurprisingly, the negative press took an immediate toll on Chipotle. Once-long queues in their restaurants disappeared and the company reported its first quarterly loss.

As an investor at that time, I was monitoring the stock closely. By May 2018, I had seen enough. The company was losing customers faster than many analysts had forecast and the turnaround seemed far away.

There was so much negative press surrounding Chipotle at that time that consumers were still staying away from the restaurant. The company had forecast full-year earnings per share of US$10, almost 30% below 2015’s earnings per share.

More worryingly, it seemed unlikely to achieve it and even if it did, the stock’s price seemed unreasonably high at that point of time. It was still trading at around US$480 per share, which gave the company a forward price-to-earnings multiple of 48 times – a lofty valuation in my view. As such, I decided to part ways with my investment, booking a loss of around 15%.

What happened next

At first, my decision seemed justified as Chipotle’s stock continued to slide, reaching a low of US$255 per share. The Mexican fast-casual chain continued to face challenges as consumers continued to stay away from its restaurants. In fact, Chipotle missed its own US$10 earnings per share target in 2017, only achieving earnings per share of US$6.17 that year.

But based on the title of this article, you probably can guess what happened next. Chipotle underwent a major change of management as Taco Bell CEO Brian Niccol was called upon to replace its founder Steve Ells as chief executive officer. The impact was almost immediate, with Niccol introducing new menu times, focusing on digital sales, a new rewards program and turning Chipotle’s image around.

In the most recent quarter, comparable store sales improved by 6.1%. In 2018, its revenue increased by 8.7% and digital sales shot up 42.4% with restaurant level operating margin improving to 18.7%.

Today, shares of Chipotle trade at US$712.44, 26% higher than my buy-in price and 48% above the price I sold off my shares at.

The lessons learnt

The speed of Chipotle’s turnaround taught me two invaluable lessons.

First, Customers have short-term memories and a strong brand is extremely important.

In fact, Chipotle is not the only case of a restaurant chain that has regained its lost customers after a major infection outbreak. Back in 2006, 71 customers got ill after an E-coli outbreak in Taco Bell. Yum! Brands, Inc, the holding company of Taco Bell, saw its share price fall 3.5% in December 2006. However, Taco Bell has gone on to do very well with Yum! Brands stock up almost five-fold since then.

Second, consumers will always return to a good product. At the end of the day, the key to a successful business is a superior product that consumers will keep coming back to. Back in early 2017, I met an American couple who had been away from the US for some time and they told me that the one thing they missed most about America was being able to have a burrito at Chipotle.

While consumers may avoid companies for some time due to negative press, a good product will eventually get customers coming back for more.

Don’t let emotions rule

As investors, there are bound to be twists and turns in some of our investments. It is easy to let emotions, such as fear, seep into our investment decisions. However, it is important to take a step back and level-headedly assess the situation.

The experience also emphasised the importance of investing in companies that have superior products and have built a brand that can withstand even the harshest negative press.

 

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore recommends Chipotle. Motley Fool Singapore contributor Jeremy Chia doesn't own shares in any companies mentioned.