With Wednesday’s sharp rally, investors that like to short stocks were tripping over each other to get to the exit. And to unwind a short holding, they had to buy back shares of the companies in which they’ve made a negative bet, known as short-covering. So even though they may have correctly identified an overvalued stock, they unwittingly pushed it higher, even further into overvalued territory.

That’s the short tale of Chipotle Mexican Grill (NYSE: CMG), the fast-casual Mexican restaurant chain, which posted one of the biggest one-day gains in its history, tacking on $8 to a fresh all-time high. Shares have now doubled from the 52-week low and have nearly quadrupled since late 2008.

This has been one great growth story. Trouble is, growth is starting to slow, even as the company’s price-to-earnings ratio (PE) is far above the restaurant pack.

To be sure, Chipotle still has robust growth prospects. But so did Walmart (NYSE: WMT) when its shares peaked in 1999. (Shares of Walmart hit $70 in 1999 and can now be had for roughly -25% less.) As Walmart’s sales began to decelerate, its P/E multiple slowly eroded. Chipotle appears headed for a similar fate.

As the table below highlights, Chipotle is on track for another stellar year, as sales are likely to grow nearly +20% and per share profits by closer to +30%.

About half of those gains are due to a series of heady price increases that led to a +8.7% jump in same store sales in the most recent quarter. But this is a price-sensitive business, and there are limits to how much higher prices can go before lunch at Chipotle’s becomes far more expensive than at other quick-service dining options. As it stands, the typical customer is paying close to $10 for lunch at Chipotle’s. The food is excellent, and just about worth that price, but not much more than that when customers can dine elsewhere at similar burrito-focused places — and for a few dollars less.

#-ad_banner-#More than likely, any future price increases will need to be much more modest, which means sales and profit growth will need to come from new store openings. Trouble is, after a rapid expansion during the past five years that now counts 1,001 stores under its belt, store growth is beginning to slow. The company has already acknowledged a degree of market saturation by shifting new stores to a smaller prototype in second-tier locations. In effect, the company has already snagged the low-hanging fruit in terms of ideal locations.

As noted earlier, this doesn’t mean Chipotle has run out of growth opportunities — only that growth is likely to slow. It happens with all retail franchises, and investors sometimes don’t notice the slowdown until its underway.

Action to Take –> Investors looking for a good short candidate after today’s rally would do well to consider Chipotle. Shares now trade for more than 30 times projected 2010 profits, yet earnings per share (EPS) growth is likely to slow to around +20% next year and perhaps half that rate the following year as new store growth slows on a percentage basis. Opening up 100 new stores when you have 500 stores implies +20% expansion (and +20% sales growth — all other things being equal). But 100 new stores on a 1,000 store base implies only +10% growth.

Even as Chipotle grows larger, its P/E ratio is likely to contract. Short sellers, which held three million shares short (according to shortsqueeze.com) were on the mark with their investment thesis — they were just premature. With short covering pushing shares up to new heights, the negative investment thesis holds even more weight.