Domino's Pizza (DPZ) Stock Offers Potential Upside

Domino’s Pizza Inc (NYSE: DPZ)

Unlike Papa John’s pizza, Domino’s Pizza is my go to take out pizza. It’s the pizza I used to eat growing up as a child. It’s the pizza that I ate during college. And it’s the pizza I still order when I’m craving a fast, take-out pie. It clued in a little late that the pizza joint I loved to order pizza from is a solid business.

Over the past 10 years, Domino’s pizza has grown revenue from $1.5 billion to $2.1 billion. Net profit has grown from $108 million to $178 million. Earnings per share has gone from $1.58 to $3.15. And total shares outstanding has went from 69 million shares to 57 million shares. In percentage terms, this translated into revenue growth of 3.4%, net profit growth of 5.1%, earnings per share growth of 7.1%, and shares outstanding dropping by 17%.

These are respectable figures for a multi-billion dollar pizza company. Domino’s, for every pizza it sells, is able to garner gross margins around 30%, operating margins around 17%, and net profit margins around 8%. These margin figures, combined with revenue and profit growth, demonstrates a fine economic engine that is able to take in raw materials and pump out pizzas for steady profits.

However, the current stock price of almost $135 might give you some sticker shock. At the current stock price, Domino’s trades at around 38.5 time earnings. Analysts’ consensus estimates for earnings per share in 2016 is $4.06, which would give a forward P/E of 33.2 times earnings. Either way you look at it – trailing twelve months earnings or forward expected 12 month earnings – Domino’s stock is fairly expensive.

When comparing the current earnings multiple to the historic P/E ratio, both the current trailing and forward P/E ratios are well above their historic norm. If we’re looking back 10 years, the normal P/E ratio is 20. If we’re looking at the previous 5 years, the normal P/E ratio is 28. Why then is the stock trading at well over 30 times earnings?

Domino’s has been expanding aggressively internationally, fueling store growth and acquiring market share. Last year, Domino’s bought Germany’s largest pizza chain, Joey’s Pizza. This acquisition will grow Domino’s presence in Europe from 212 store to 775, and increasing global store count to around 1900. Additionally, Domino’s also bought French pizza company Pizza Sprint, increasing stores by 89 in France to a total of 330.

The market has obviously been excited about the expansion effort and the increased sales this will generate in the future, with analysts pegging growth over the next 5 years at 14%. If Domino’s can hit 14% earnings per share growth over the next 5 years and if it continues to trade in an earnings multiple range of P/E 30 to P/E 38.5, even at today’s stock price, the stock could compound at an annual average growth rate between 9% to 15%.

While I would personally wait for a lower P/E multiple closer aligned to historical trends to initiate a position, if you look through the financials and annual reports and feel confident that the management and analysts’ expectations for growth are accurate, even at today’s seemingly high stock price and earnings multiple, Domino’s Pizza might be a strong addition to the portfolio.

Disclosure: This author has no positions in any stocks mentioned and does not plan to open any positions in any stocks mentioned for at least 72 hours after publication of this article.