JL: So, care to guess what’s on my mind?

CASH: Uh, how about you just tell me, and we’ll pretend I guessed right.

JL: OK. The answer is “burritos.”

CASH: I’m afraid to ask why…

JL: What, you don’t remember? A couple months ago — in early May, to be exact — we talked about one of your favorite stocks, Chipotle Mexican Grill (CMG:NYSE).

CASH: Oh yeah! Chipotle was a major home run. The stock was offered at $22 in early 2006… by the end of 2007 it was well over $150. And investors who didn’t catch the IPO price still had a chance to jump on the rocket ride for huge upside. It’s a powerful example of what the right IPO at the right time can do.

JL: Yep, the early gains were definitely impressive. More than 600% if I recall correctly. But that wasn’t the gist of our conversation in May. The Taipan Daily episode was “Cash Tours the Dark Side,” and you were talking about going short CMG back then.

CASH: Man, you file away everything in that big brain of yours, don’t you? You’re right… CMG was a big winner coming and going for me. Not only was I excited to grab hold of CMG shares for potential 600% gains on the upside, I got excited again when investors took Chipotle too far — making the stock a prime short candidate as it fell back to earth.

JL: Right. So again, looking back on our conversation (which readers can do here), we first started talking about a CMG short on May 6. That was a solid 30 points ago, and CMG shares have coughed up nearly a third of their value since you made that call. Not a bad little short.

CASH: Nope, not bad at all. And there are plenty more great plays out there, too — a few of which are on the books of IPO Confidential as we speak. But you said you had burritos on your mind… What’s the reason for bringing this up again here and now? If I know you like I think I do, the hamster wheel is turning.

JL: Is it that obvious? Considering we’ve been pals for nine years, I guess it is. I’d like to know your current opinion on CMG — partly because I just came across a strongly bullish analyst opinion on the stock.

CASH: Well, let’s see… I’m pretty confident in saying that this is a really, really risky time to be dipping into a growth stock like Chipotle. You can certainly buy the stock for less than you would have paid at the beginning of the year — a whopping 50% less, in fact — but there are many external pressures that haven’t been fully realized in the share price yet. Of course, this is just my humble opinion…

JL: I can think of many colorful words to describe you, ol’ buddy, but “humble” isn’t one of them.

CASH: Touché. What about this bullish analyst opinion you cited? What was the main reason for being bullish CMG?

JL: That’s the part that felt sketchy to me. There was the standard long-term reasoning for liking CMG — quality food, quality service, nice atmosphere, etc — but a big reason cited for buying was overreaction from Wall Street.

CASH: “Overreaction”? That sounds like one of those fishy analyst buzzwords.

JL: The guy was saying CMG got crushed because of an earnings miss. When the quarterly numbers were light by a penny, the stock tanked big time, wiping $540 million off the company’s value. The analyst pegged the sell-off as a huge blunder by Wall Street, saying there was no reason for CMG to fall so hard on a miss of one lousy penny. In his view, this made Chipotle a great value buy.

CASH: Ack! You’re kidding me,

right? This guy honestly thinks that the stock sold off just because of a one-penny miss? He really thinks that the rate of growth is healthy? He honestly wants to own the stock at more than 25 times “projected” earnings for this year? In this environment?

JL: Easy there, friendo. No need to spit coffee all over your trading screens…

CASH: I know, it’s not you I’m upset with. But… Hey, wait a minute. You knew that would get a rise out of me, didn’t you? You just wanted to see my reaction…

JL: No comment. Heh.

CASH: OK, I’ll play along. Given all that I’ve seen in the trading and investing game, I still can’t believe the wacky rationale out there sometimes. The penny miss actually had NOTHING to do with why Chipotle sold off so sharply. That analyst apparently has no idea what really moves a high-multiple growth stock like CMG.

JL: So enlighten our readers. What caused Chipotle to crack wide open if it wasn’t the penny earnings miss?

CASH: Well, as you know, anytime a company reports earnings, the headline numbers can be compared with the picture from the rearview mirror. The headline numbers tell us what happened, in the past tense… not what’s happening right now, or more even more important, the outlook for future business.

JL: So Wall Street didn’t pummel CMG because of a single penny. They pummeled them because the outlook for the future was darker than investors could take, especially with the stock trading at a high multiple.

CASH: You got it. Looking out the windshield (as opposed to the rearview mirror) reveals a much uglier picture. Management actually noted that they were seeing weakening trends in the upcoming quarter that bode further ill for CMG’s business.

JL: You’re talking the same ills we covered back in May, when you called out CMG for a potential short. Consumers tightening up, lower cost competitors, high prices for ingredients, and so on.

CASH: Those are the basic factors, yes. They’ve played a big role in taking the stock way down from its $150 high, but none of the downside factors for CMG have been fully “brought to bear” yet.

JL: Groan…

CASH: I couldn’t resist. Anyway, looking at CMG now, and considering the still-high earnings multiple, the most positive thing you could say is that the company is “reasonably priced.” But even that assumes a positive outlook on the economy, a firm grip on what Chipotle will be earning in future quarters, and a lack of better investing opportunities.

JL: That’s a lot of assuming.

CASH: No doubt. And the truth is that we are NOT in a strong economy, we are NOT confident that CMG can continue to grow at its current rates, and I am NOT anxious to put capital to work in growth stories right now. The scenario simply has nothing exciting about it.

JL: You mentioned the “still-high earnings multiple.” So clearly you still think Chipotle is expensive in that regard, even after the big earnings haircut it took. We’ve talked about sky-high earnings multiples in the past. I’m reminded of the short arguments you made against VMWare (VMW:NYSE) and Salesforce.com (CRM:NYSE).

CASH: Yep. Those are a couple of other names that simply got way ahead of themselves — to our bottom-line profit, I might add. The simple reality is, there’s a time and a place for buying high-multiple growth companies. As a trader, I’ve made plenty of money buying hot growth names at a multiple of 50 times earnings, and then selling them for huge gains at a multiple of 150 times earnings. That’s the way to make big gains in go-go bull markets.

JL: But this ain’t no go-go bull market.

CASH: Oh, heck no. That’s why we’re raking in so much dough on the short side rather than the long side right now. If you’re not in a bull market, buying growth stocks at anything more than rock-bottom multiples can be a death wish. Any uncertainty with future earnings can take a huge chunk out of the multiple in a moment’s notice.

JL: I’ll say. We saw VMWare drop from $53 to $40 in just one day, not long after you tipped readers to short the stock right here in Taipan Daily. And Salesforce.com dropped close to 20% overnight as one of the short positions in IPO Confidential. (Our paid subscribers were, no doubt, excited to see that gain.)

CASH: Yep, and that’s where most investors’ danger becomes our opportunity. We can short these growth names during a bear market and make 40% to 60% as the stock declines… or even better, buy puts on the same names and watch profits stack up to 200%, 400% or what have you.

JL: It’s like Jesse Livermore once said: “There is only one side to be on in the stock market. Not the bull side or the bear side, but the right side.” I guess that wisdom rings extra true with high-multiple growth stocks.

CASH: Absolutely. There are some solid long plays out there, even in crazy markets like this one — but there’s no doubt that now is the time for bears to be raking in the dough. And I love how our subscribers are doing just that in IPO Confidential.

JL: You and me both, amigo. We’ll catch up again soon.

Justice Litle, Editorial Director, Taipan Publishing Group

Source: High-Multiple Growth Stocks: When to Hold ‘Em, When to Fold ‘Em, and When to Go Short