What Crocs, Netflix And Chipotle Have In Common

| About: Chipotle Mexican (CMG)

Guess what these companies are:

"The next Nike"

"The next HBO"

"The next McDonald's"

In history "The next XXX" has jinxed many stocks. It often means the market gets over excited about a company and it becomes a disastrous investment. One can obviously use such sentiment to create a "sell short index" by observing how media, especially analysts behave toward an overvalued stock.

The next Nike (NKE)

For most people, the memory is still quite fresh about those ugly Crocs (CROX) sandals. Crocs was publicly listed as an overvalued stock. It became so popular in the summer of 2006 that you could not go anywhere without seeing young people wearing them. However, the fundamentals just don't match. At around $45 in 2007, Crocs was already a very outrageously valued stock. It was around that time, I started to hear "The next Nike" on Crocs. Crocs, at the same time, started product line expansion by entering into alternative shoe designs using the same plastic. It even expanded into clothing for a while. On the balance sheet, keen investors started to observe warning signs. Earnings were exaggerated by mountain piling inventory. The snow storm finally came in late 2007. Unfortunately, the financial crisis came in 2008. A deteriorating business coupled with a bad economy; Crocs dipped to as low as $2, as over 90% drop from its bubble peak.

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The next HBO (TWX)

A Warner Brother's executive calls the company the "Albanian army." Analysts and stock hobbyists called it "the next HBO." The rise and fall of Netflix (NFLX) were both quite magnificent. We know the highest cable penetration in the United States is about 30 million households. Analysts believed Netflix could hit 50% of the households in the U.S. when it had fewer than 20 million subscribers. From $300 to $60, Netflix lost 80% of its value from its bubble peak. How much is Netflix worth?

Currently, it has about 12 million DVD subscribers and 20 million online subscribers, that's $3.5 billion a year in revenue. A 10% profit margin, and a price/earnings (P/E) multiple of 10-15, it's worth $3.5-$5 billion. If Netflix can maintain its subscriber base and margin, it's worth between $65~95.

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The next McDonald's (MCD)

The previous two cases unfolded. The story of "the next McDonald's" is still in the making. First of all, Chipotle Mexican Grill (CMG) is not similar to McDonald's -- it is not even a franchise-style business. The main reason for Chipotle's fall is over valuation, just like in the case of both Crocs and Netflix. The chief indicators include:

Market value per restaurant

Chipotle: $10 million
McDonald's: $3 million
Olive Garden or Red Lobster: $3.5 million
Red Robins (RRGB): $1.1 million
Wendy's (WEN): $290 thousand

Operating cash flow

Chipotle has an OCF growth of sub-20%, while its price/OCF ratio is almost 50. A generous but more reasonable ratio of 25 given its growing speed means a price of about $160, almost half of the current price.

Insiders selling

Always a warning sign, Chipotle insiders are selling their shares like there is no tomorrow. During the past three months, there were 58 insider selling occasions and they sold a combined 418,597 shares. Chipotle has a total of 31 million shares and insiders hold a tiny portion: 1.68%.

Forward valuation

Generally I do not trust analysts' forecasts because they are rarely correct. They tend to overestimate hot stocks and underestimate underdogs, which is why the PEG ratio (price/earnings growth) of Chipotle may be another indicator of its over valuation. Even by analysts' likely-to-be inflated estimates, Chipotle's PEG ratio is still a whopping 2.2 (a PEG ratio of 1 is considered "fair").

The market, and possibly big manipulative money are valuing Chipotle as if it were cooking dollar bills, not burritos. The market is no Planet Pandora; Chipotle is not going to float like Hallelujah Mountains. It will sink. But the million dollar question is when? Many readers commented on my previous article about timing.

I admit it is difficult to accurately time when the 75% drop is going to happen. For that purpose, I have to count on trading activities. As you can tell from the chart, Chipotle's trading volume has thinned down significantly since it hit $300. This means three things: 1) the big money is not buying actively anymore; 2) the big money cannot dump its shares without a high volume and a lot of trading activity; and most important of all, 3) the first shoe drop is pending.

There's a high probability that Chipotle will drop $100 within two earning report cycles. Either bad earnings data or a not-rosy-enough growth prospect would do the job.

How to play this? I'm going to use put options, risky but at least I can control the risk compared with short selling shares.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.