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Shares of Chipotle Mexican Grill, Inc. (CMG) continue to trade lower as prospects for the overall economy become dim. The most recent catalyst for a lower stock price was a report offered by Morgan Stanley (MS) which outlined concerns for the entire retail industry. In the report, Morgan named five stocks dubbed its “fading five” which were likely to see lower stock prices. The five names were Abercrombie & Fitch Co. (ANF), Nordstrom, Inc. (JWN), Chipotle Mexican Grill, Inc. (CMG), Sears Holding Corporation (SHLD), and Best Buy Co., Inc. (BBY).

One of the temptations during a bear market is to find beaten up stocks that are good values. The problem is that often good values become even better values as prices continue to drop due to investor fear, declining earnings, and sharply lower equity multiples. This scenario is often referred to as a “value trap” in which unscrupulous buyers become convinced that lower prices are indeed better values for companies they wish to own.

While a bear market is certainly an excellent time to pick up stocks at a cheap value, good timing can make the difference between the “trade of a lifetime” and slow, frustrating financial death. Besides timing, leverage is also a very important factor. If you want to get the most bang for your buck, it is very easy to rationalize buying a depressed growth stock on margin (borrowing half of the value of your purchase). However, this is a recipe for disaster as even a 20% loss in the stock will cut out almost half of your capital and likely trigger ugly margin calls. If you are correct in picking up a stock at the low, it is probably not necessary to use margin as the returns on the stock by itself will likely be very strong. The danger far outweighs the additional benefit.

CMG strikes me as a name that is likely to suck in bargain buyers. I have felt tempted myself as gains from being short the name have accumulated. Out of discipline, I have covered a portion of my short sale to book some profits, but more than half of the short position still remains on my books. Food inflation still remains a significant factor as the company struggles to keep its costs under control. The employment picture in the US is not pretty and that causes less in the way of discretionary spending. These factors alone are concern enough, but with CMG trading at more than 20 times estimates for 2009, the stock seems to be pricing in an overly optimistic picture for the restaurant company. I would caution growth stock buyers to steer clear of this name until the multiple is much more of a bargain, and the earnings picture becomes clearer.

FD: Author has a short position in CMG

Additional Reading:

Barrons reports hedge fund accumulating CMG

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