Domino’s Pizza shares – buy, hold or sell?

Buying Domino’s Pizza shares will give you part ownership of a Master Franchise of the world’s leading pizza delivery company.  Domino’s Pizza shares are listed on the FTSE 250, and the company has a market cap of around £1 billion.

History

From 1 store in 1985 to over 800 stores with 23,000 staff and franchise team members, Domino’s Pizza Group has grown rapidly from effectively nothing up to a £1 billion market cap.  The recipe is simple – They make good pizzas and deliver them quickly, using a franchise model which allows growth without the need for much capital expenditure.

Having largely covered the UK and Ireland in recent years, it’s now expanding into other countries, starting with Germany and Switzerland.

You can see the company’s financial results below.

The process of selecting a company to invest in can be broken down into two major steps:

1. Reviewing the quality of a company involves looking at the income it generates for shareholders, how sustainable that income is and how likely it is to grow in the future.
2. Buying the company’s shares at an attractively low price, with attractively high yields, if possible.

Domino’s Pizza Group – Is it a quality company?

Quality is a relative term, so it makes sense to compare the attributes of a company to the average company (i.e. the market) to see if it is above average quality or below average.

Growth rate

As you can see from the chart above, Domino’s has an incredible track record of success.  Revenues have grown by about 17% a year, while earnings and dividends have grown at closer to 30% a year for the last decade.

The overall growth rate is 26%, which compares very favourably against the FTSE 100, which has grown earnings and dividends at closer to 4% a year in the last decade.

There is no doubt about it; Domino’s has been a high-growth company, and it’s important to remember that even as a value investor, growth is a key part of the intrinsic value of a business.

Growth quality

Just as important as the rate of growth is the quality of that growth.  Domino’s doesn’t disappoint in this regard either and has notched up a 100% record of revenue, profit and dividend growth in the last ten years.  Very few companies can match that sort of consistency.

In comparison, the companies in the FTSE 100 have managed in aggregate to generate and grow profits and dividends 81% of the time.

So Domino’s Pizza has not only been high growth, it has produced the highest quality growth possible.

Debt ratio

A company with high debt is like a house with weak foundations, and they’re generally best avoided.  However, there is more good news on this front as Domino’s has interest-bearing debts of around £50 million, which is relatively low compared to the profits it generates.

Most companies can handle debts that are some multiple of their earnings across the business cycle, and for me, the maximum debt allowed is five times an estimate of average earnings over the next business cycle.

Domino’s has a debt ratio of 1.2, which is well within the acceptable and manageable range of values.

A high-quality, high-growth business

From this initial look at Domino’s financial past and present, it seems to be a very high-quality business.  Growth is strong and incredibly consistent, and debt levels appear to be low.

Domino’s Pizza shares – Are they good value?

Moving on from the company to its shares, the following analysis was carried out with the share price at 544p and the FTSE 100 at 6,620.

Cyclically adjusted PE ratio

Paying a low price for a company is just as important as buying a good company, and using the average of the last decade’s earnings as a measure of value is a better place to start than the standard PE, which just looks at the market price relative to current earnings.

Domino’s has a PE10 value of 44.6, while the FTSE 100 is at 14.7, so on that measure, Dominos is very expensive indeed.  Ben Graham suggested avoiding stocks that were priced at more than 20 times average earnings, but that is a little restrictive, especially when considering high-quality businesses.

Quality companies should command a premium price, and it is for investors to work out how much of a premium is reasonable and how much is too much.

Dividend yield

The good old dividend yield is a common measure of value, although once again, it may be better to average dividends over the last decade rather than just using the latest payment.

However, when you’re looking at high-quality, very consistent companies, the current yield is still useful.  Domino’s Pizza shares currently have a dividend yield of 2.7%, while the FTSE 100 manages 3.5%.

Once again, Domino’s Pizza shares are relatively expensive with a lower yield than average, but that should be expected for a high-growth, high-quality business.

The question is, how much yield are you willing to give up today in the hope of future growth tomorrow?

Buy, hold or sell?

Looking at the analysis above, you can see that Domino’s Pizza scores better than average as a company.  Its ability to generate high rates of growth, year after year, put it in the top few percent of all companies in terms of medium-term future prospects.

It is a fantastic business which has had enormous success over the years.  At the right price, it is exactly the sort of company that would make it into the UK Value Investor Model Portfolio.  It’s profitable, dividend-paying, growing and relatively low-risk.

On the other hand, the shares are way more expensive than the average company, with a cyclically adjusted PE more than three times the average and a dividend yield about a quarter below average too.

There is no question that Domino’s Pizza Group should have a premium rating.  But how big should that premium be?

UK Value Investor’s Stock Screen currently ranks Domino’s at position 76 out of 219 stocks.  Those stocks are pre-selected and only include companies with a decade-long history of dividend payments, so it’s a tough group to beat.  Position 76 is pretty good and far better than the FTSE 100, which came in at position 130.

However, if Domino’s were put into the UK Value Investor Model Portfolio, it would be the second lowest-ranking stock in the portfolio.  So for the Model Portfolio, Domino’s shares are closer to being a sell than a buy or hold.

The same principle of comparing potential investments to existing investments applies to you.  Domino’s is an above-average business trading at a slight premium to the average business, but overall it looks like the shares are quite attractively priced.  But whether they are a buy, a hold or a sell depends on what you already have in your portfolio and your assessment of the quality and value of the shares you already own.

Once you have that information, your next stock pick will make much more sense in relation to the rest of your portfolio.

At the time of writing, John does not own any of the shares mentioned.  For the UKVI Model Portfolio, this quantitative analysis would be followed by a series of qualitative questions about the company and its industry.