The financial press has gotten great mileage out of the hottest stock in the dining sector — Chipotle Mexican Grill (NYSE: CMG). And why not? It’s been a great growth story as sales shot up from $315 million in 2003 to roughly $1.83 billion in 2010. Yet some investors are just now beginning to notice some early warning signs that appeared in 2011. 

Though sales rose another 24% last year to $2.27 billion compared with 2010, EBITDA, operating and net profit margins all dipped slightly — after each of those metrics had steadily risen in prior years. 

But more cracks are emerging. Shares had risen from less than $50 in late 2008 to more than $400 this past spring, but took a big hit in late July as investors took note of slowing growth. A number of investors have reflexively seen that as a fresh buying opportunity, and shares have rebounded more than $50 since the month began.

Yet for investors to think that the second-quarter-related drop was just a blip on the screen, it’s time to take a fresh look at what’s really happening at Chipotle.

#-ad_banner-#While the financial community obsesses over a range of financial metrics, the only one that matters for any retailer is foot traffic. For a number of years, Chipotle continued to win new converts, thanks to its combination of freshness, taste and value. That led to steady 6% to 8% growth in customers every quarter, on a year-over-year basis. Yet in the second quarter of 2012, that figure fell below 4% for the first time in several years. (Same store sales are a few percentage points higher, thanks to price increases.)

Could it be that rivals are starting to lure customers back by copying the traits that Chipotle offers? Could it be that the company is hard-pressed to find new consumers that have yet to experience the “fresh Mexican” restaurant style? Could it be that the company’s newly-opened stores are in second-tier locations  because the company has already picked the low-hanging fruit of prime real estate locations?

It’s probably some combination of all three. On the most recent quarterly conference call, management cited macro-economic weakness and increased promotions by rivals for the incipient weakness. Regardless, slowing growth completely alters the trajectory for this high-growth business model. 

Let’s look at where Chipotle’s profits had been trending and where they are now trending, using Goldman Sachs’ earnings models as an example. Prior to the second-quarter results, Chipotle had been expected to boost earnings from around $9.25 per share this year to around $15.25 per share by 2014. Now that 2014 forecast is $13.75 per share. That’s a nearly 10% reduction. And instead of EPS growth of 65% over that two-year time-frame, it now looks like it could rise at a 48% pace, or roughly 22% annually. 

Of perhaps greater concern, this business is quickly moving toward market saturation. (Chipotle is rolling out new concepts such as a “fresh Asian” chain of eateries, but they are as yet unproven.) So beyond 2014, Chipotle’s profits are unlikely to grow at a fast clip.

Yet here’s the rub. This stock’s big September rebound has pushed the 2014 price-to-earnings (P/E) ratio (using Goldman’s numbers) back up to 25. Note that this is above the forecasted 22% EPS growth rate, in other words, Chipotle’s 2014 P/E is now higher than its forecasted earnings growth, which is a key marker of overvaluation.

Risks to Consider: As an upside risk, it’s important to track Chipotle’s newer Asian chain, known as ShopHouse. If that chain is successful, then Chipotle may be able to maintain robust growth rates beyond 2014.

Action to Take –> The quick move below $300 in July was a key tell for this stock. As we’ve seen with Netflix (Nasdaq: NFLX) and many other high-flying stocks, a first break in a price chart is followed up by a snapback, thanks to still-optimistic buyers, but then further breaks start to dent the stock more significantly. Chipotle is unlikely to truly crash and burn as Netflix has, but slowing growth means that investors may eventually look to target a P/E of 20 for this stock (based on 2014 profits). This means shares may drop another 20% from current levels to touch $275, breaching the recent intra-year lows, once another tepid quarter hits the tape.