It’s alarmingly difficult to build a forecast for Chipotle Mexican Grill (NYSE: CMG). Sure, the performance of CMG stock is horrendous, with the equity down more than 16% on a year-to-date basis. Even worse, since mid-June 2024, Chipotle has dropped roughly 53%. What used to be a popular fast-casual outlet has quickly lost favor with discerning investors.
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Still, that’s not the basis of my forecasting concerns for CMG stock. In a deterministic system — such as a criminal trial — evidence is additive. The more evidence that is presented, the narrower the probability space becomes for plausible explanations for the event at hand. However, in a non-deterministic system (like the equities market), evidence is multiplicative.
That right there presents a mathematical dilemma for the investment analyst. Basically, the more rigorous a thesis becomes, the less likely it is that the custody of interlinking propositions turns true.
While this concept initially sounds confusing, it’s quite logical. In a criminal trial, something happened. Therefore, evidence accumulates toward an explanation of the crime that occurred. However, in the equities space, the projected outcome is exactly that — a projection. It hasn’t happened and as such, what we would call evidence are really assumptions.
The kicker is that each assumption must be true for the conditioned outcome to materialize. In the case of CMG stock, the bullish argument — at its most distilled — states that the business will remain fundamentally sound and that the share price is now so low that the market will rerate it higher.
At first glance, these two assumptions might seem relatively reasonable. But if we were to assign a confidence level of 70% that each of these factors will ring true, the combined probability that they will simultaneously materialize — and thus lead to a higher CMG stock price — would come out to only 49%.
You might as well flip a coin and that’s the problem. Unless we truly have incredibly high confidence in the assumptions undergirding Chipotle stock, any narrative-based thesis for the security is going to be mathematically weak.
Using an Inductive Approach to Trade CMG Stock
It’s one of the more shocking realizations but most articles that utilize fundamental analysis on volatile securities like CMG stock are likely to be useless. That’s not necessarily because the analysts writing them are incompetent. No, the more plausible answer is the nature of the beast.
If you look at a rock-solid blue chip armed with a durable core business, fundamental analysis should work beautifully. Basically, you would be making two assumptions: first, key financial metrics like growth or earnings will expand and second, that the metrics will be robust enough to attract investor capital.
For a reliable industry leader, you can probably assign a 95% confidence level on both of these factors. Compounded, the probability that these two assumptions will ring true comes out to 90.25% — a strong investment, at least from a plausibility standpoint. However, highly plausible investments tend to generate less-generous returns, which brings us back to CMG stock.
Any assumptions we make about Chipotle at this rough economic juncture will invariably suffer from low confidence. When compounded, the chain of projected implausible events leads to a weak forecast. Fortunately, we can sidestep this problem by considering the conditional structure that leads to various outputs.
For example, Amazon (NASDAQ: AMZN) doesn’t just guess what you will buy. Instead, it runs extensive datamining algorithms and predicts consumer behavior, which correlates with the underlying environment. That’s why Amazon will have umbrellas stacked in warehouse inventory as a storm approaches a major metropolitan area.
We can use a similar principle in the equities market. I think it’s fair to say that most of us accept the presupposition that the equities market is not purely random. And if that is indeed the case, then it stands to reason that a stock will respond differently when coming off from a bullish cycle as opposed to a bearish cycle.
Most importantly, if trading CMG stock based on conditioned signals leads to a forward performance that positively diverges from a random baseline, this dynamic could potentially be exploited. My argument is that because Chipotle stock has recently suffered extensive downside, the next series of movements may be more robust than usual due to mean reversion.
Drilling Deeper into the Numbers for Chipotle Stock
Let’s dig further into the hard numbers. Using a dataset from January 2019 onward, if we were to trade CMG stock randomly and hold it for a 10-week period, the expected forward distribution would be between $30.60 and $32.20 (assuming a closing price of $30.95, Tuesday’s close). Probability density has been observed to peak at around $31.45, meaning that Chipotle enjoys a positive bias.
However, in the last 10 weeks, CMG stock printed only three up weeks, leading to an overall downward slope across the period. Conditioned under this signal, CMG is likely to range between $29 and $36 over the next 10 weeks. It’s fair to point out that peak probability density would likely be similar to the random baseline. Still, the overall expansion of observed outcomes is net positive, which may incentivize bullish speculation.
What’s particularly interesting regarding the above 3-7-D sequence is that in the fourth to fifth week, Chipotle stock has been observed to reach near the $33 level. If these observed trends were to continue this time around, the 32/33 bull call spread expiring July 24 would be a tempting proposition.
As mentioned above, the $33 second-leg strike would represent a realistic target. Further, the spread’s breakeven price of $32.49 adds some modest margin for traders. That comes out to a 5% lift relative to CMG’s most recent closing price. Finally, the nominal cost is arguably very reasonable at $49 per spread.
I can’t tell you whether Chipotle is a good investment opportunity over the long run — the compounded math makes such pronouncements dubious. But if we’re talking about the near-term picture, CMG stock does look intriguing for the risk-tolerant speculator.
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