Valuation multiples help investors make investment decisions. Factors such as perceived growth, investors’ willingness to pay for the stock, risks, and uncertainties drives company’s valuation multiples.
Of the various available multiples, we have considered forward PE (price-to-earnings) multiples due to the high visibility of Domino’s Pizza’s (DPZ) earnings. Forward PE multiples are calculated by dividing Domino’s stock price by its earnings forecast for the next four quarters.
Domino’s PE multiple
Since the announcement of 4Q16 earnings on February 28, 2017, Domino’s forward PE multiple has fallen from 36.2x to 32.3x. A report from M Science stating that Domino’s 1Q17 sales would be lower than analysts’ estimate could have led to fall in its stock price and PE multiple.
Comparatively, on the same day, Domino’s peers, Papa John’s (PZZA) and Yum! Brands (YUM) were trading at PE multiple of 27.0x, and 22.8x, respectively. The business model adopted by Domino’s allows the company to expand its business aggressively while technological advancements and initiatives to improve customer experience have helped the company post higher SSSG (same-store sales growth). These factors have allowed the company to trade at a higher valuation multiple than its peers.
The implementation of technological advancements is expected to increase Domino’s expenses. If these initiatives fail to generate expected sales, the increased expenses could put pressure on Domino’s 1Q17 margins, lowering its earnings. For the next four quarters, analysts expect Domino’s to post EPS growth of 21.6%, which could have been factored into its current stock price. If the company posts lower-than-expected earnings, the selling pressure could lower its valuation multiple.
You could mitigate company-specific risks by investing in the iShares U.S. Consumer Services ETF (IYC), which invests 11.6% of its holdings in restaurants and travel companies.
Next, we’ll look at analysts’ target price and recommendations.