Domino's Pizza: Absurdly overpriced

Every so often a very successful business becomes a hot stock. Domino’s Pizza is sizzling now but it won’t last.

I’m calling it. Domino’s Pizza Enterprises (ASX: DMP) is the most expensive large company on the ASX. There is simply no justification for this stock being worth its market capitalisation of $6bn.

Yes, Domino’s historical growth record has been tremendous. Over the 10 years to 2015, earnings per share has more than tripled to $0.74. Over that time, the pizza store franchisor has expanded into New Zealand, France, Belgium, the Netherlands, Germany and Japan.

Hot stocks invariably have an impressive story that helps justify the case. In Domino’s case, it’s using technology to cook and deliver piping hot pizzas faster than anyone else. Joe from your local Italian pizza joint simply can’t compete. Nor can Eagle Boys Pizza, which this week went into administration.

Combine that with overseas acquisitions at prices that are cheap relative to Domino’s itself as well as an aggressive store rollout program, and sales are soaring. Same-store sales growth in the first half of 2016 was an outstanding 10.3% across the group. Australia and New Zealand same-store sales growth was even better at 13.8%.

Crazy-high

It’s easy to admire Domino’s, it’s certainly well-managed, and strong growth looks assured for a few years yet. But any way you cut it, the share price is crazy-high.

Consensus earnings per share forecasts are for $1.02, $1.35 and $1.68 for 2016, 2017 and 2018 respectively. That sort of growth is hard to find elsewhere but that doesn’t mean you should pay any price for it. A multiple of 42 times forecast 2018 earnings provides absolutely no room for error.

At that price, you don’t need to know what might go wrong. All you need to know is that, if something does, it will be very painful for shareholders.

Perhaps Australian consumer preferences might change; there’s supposedly a trend towards healthier eating after all. Perhaps Domino’s German acquisition might falter, or it could end up in a dispute with the owner of the Domino’s brand, Domino’s Pizza Inc. (NYSE: DPZ).

A $100 stock?

Of course there are cheerleaders. Fund manager Hyperion made its name picking high-growth stocks like Domino’s and REA Group (ASX: REA) and its investors have been richly rewarded. Hyperion, which owns almost 10% of Domino’s, is a believer in the store rollout/technology story and is on record calling it a $100 stock (by 2020). Credit where credit is due – when it comes to picking growth stocks, Hyperion is best-in-class.

By contrast, value investors sometimes find it difficult to identify early-stage growth stocks; they invariably look a little expensive. Intelligent Investor – as well as this analyst – have certainly under-estimated Domino’s. We don’t apologise for that – our conservatism also helps us avoid plenty of duds.

What we think we're good at, though, is recognising extreme over-pricing. If you want proof, see our series of ‘time bombs’ articles on overpriced stocks here, here, and here. Of the 16 time bombs flagged in those various articles, 4 went bankrupt and 8 have fallen by more than 80%.

Domino’s is a great business but it’s also an extremely overpriced stock. I can’t guarantee the share price won’t rise further but I will guarantee one thing – Domino’s Pizza Enterprises is about as far from good value as it’s possible to be.

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