Domino's Pizza, Inc.'s (NYSE:DPZ) Share Price Not Quite Adding Up

Domino's Pizza, Inc.'s (NYSE:DPZ) price-to-earnings (or "P/E") ratio of 26.1x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 17x and even P/E's below 10x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Recent times have been pleasing for Domino's Pizza as its earnings have risen in spite of the market's earnings going into reverse. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.

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How Is Domino's Pizza's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as high as Domino's Pizza's is when the company's growth is on track to outshine the market.

If we review the last year of earnings growth, the company posted a terrific increase of 23%. The strong recent performance means it was also able to grow EPS by 30% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 7.6% per year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 10% each year, which is noticeably more attractive.

In light of this, it's alarming that Domino's Pizza's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Domino's Pizza's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Domino's Pizza that you should be aware of.

If these risks are making you reconsider your opinion on Domino's Pizza, explore our interactive list of high quality stocks to get an idea of what else is out there.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.