2 Stocks To Buy Using The Chipotle Example

| About: Yelp (YELP)

After reviewing the top gainers in the S&P 500 since March 9, 2009 provided by Bespoke Investment Group, one stock really stuck out. Chipotle Mexican Grill (NYSE:CMG) generated one of the largest gains at nearly 1,000% during that period. What really stood out is that Chipotle unlike other stocks on the list was considered a high quality company all along yet it presented several extreme-buying opportunities over those years.

Using that same general concept of buying quality stocks on dips, a couple of top performing companies with huge opportunities really stick out. Both Yelp (NYSE:YELP) and Zillow (NASDAQ:Z) have very desirable, market leading models. The issue is that the stocks trade at high multiples that make the stocks difficult to purchase at the current levels. Following the Chipotle example, the market will provide several opportunities in the future to buy these stocks at lower multiples. The key is whether investors are prepared and ready to pounce when it occurs.

Chipotle Example

The Bespoke list includes stocks in the S&P 1500 that soared over 1,000% during that time period. The problem with this list is that the majority of the stocks were difficult to predict that huge gains were ahead. In the cast of the S&P 500 list, a few stocks including Chipotle probably could've been predicted to have a strong future.

Click to enlarge

Chipotle went public back in 2006 after being spun off from McDonald's (NYSE:MCD). The stock surged over the next couple of years to reach over $150, but the financial collapse at the end of 2008 caused the stock to collapse. As the chart below shows, the stock surged over the next couple of years to reach over $440, yet not long after that fears about competition from the low end Mexican food providers in the form of Taco Bell sent the stock plunging below $250. That situation provided another extreme buying opportunity with the stock surging to over $500 within a year.

CMG Chart

CMG data by YCharts

All the while, investors claimed issues with high valuations and concerns about future growth. Analysts continue to expect long-term earnings growth of 21% and the stock trades at a forward PE of over 40. Clearly the stock trades at a maximum valuation even after all these years.

The major point to apply to these other stocks is that an investor buying at $150 in late 2007 has a very different perspective and account balance than the one buying near the low in mid-2008. The 1,000% gain quickly dissapates into less than a 300% gain during a longer time period.

Business Angle

Both Yelp and Zillow have the business angle similar to a Google (NASDAQ:GOOG) as opposed to a social network. Consumers flock to the services in order to find their dream house or locate a great restaurant in the area. In both cases, the service isn't based on a social connection that may disappear in the future. It's all based on whether Yelp or Zillow provides the best option for obtaining the service desired by the customer.

Yelp has the potential of becoming the new Yellow Pages and the provider of the best content on local businesses. The stock has surged to a market value of over $4 billion with expectations of revenue surging over 50% to $346 million next year.

Zillow has the opportunity to be the dominant player in the online real estate marketplace. Home buyers looking for a house, mortgage, or real estate agent could flock to the associated websites. With a valuation just below $3 billion and revenue expected to be shy of $300 million next year, the stock trades at a high multiple, but revenue growth of 44% next year probably justifies it.

Chart - revenue growth

YELP Revenue (Quarterly YoY Growth) Chart

YELP Revenue (Quarterly YoY Growth) data by YCharts


In my opinion, the question isn't whether these stocks eventually reach valuations of $10 billion or even $20 billion, but whether investors can obtain the stocks at much lower valuations during periods of weakness along that path. The Chipotle Mexican Grill example suggests that periods of extreme weakness will occur in the future. Remember that Chipotle was one of the best performing stocks in the last few years, yet it had a couple of periods of roughly 50% declines. The smart investor will take advantage when it occurs to Yelp and Zillow and greatly enhance investor returns.

Ultimately this theory applies to any high quality stocks, the key being that investors must do research prior to a collapse to identify the quality stocks. Finally when the major selloff occurs it shoiuld be relished and pounced on in order to achieve these outsized gains.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.