Is Domino’s Pizza, Inc.’s (NYSE:DPZ) High P/E Ratio A Problem For Investors?

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use Domino’s Pizza, Inc.’s (NYSE:DPZ) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Domino’s Pizza’s P/E ratio is 31.81. That means that at current prices, buyers pay $31.81 for every $1 in trailing yearly profits.

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Check out our latest analysis for Domino’s Pizza

How Do I Calculate Domino’s Pizza’s Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Domino’s Pizza:

P/E of 31.81 = $281.25 ÷ $8.84 (Based on the year to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

It’s nice to see that Domino’s Pizza grew EPS by a stonking 30% in the last year. And its annual EPS growth rate over 5 years is 27%. With that performance, I would expect it to have an above average P/E ratio.

How Does Domino’s Pizza’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Domino’s Pizza has a higher P/E than the average (23.1) P/E for companies in the hospitality industry.

NYSE:DPZ Price Estimation Relative to Market, May 20th 2019
NYSE:DPZ Price Estimation Relative to Market, May 20th 2019

Its relatively high P/E ratio indicates that Domino’s Pizza shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

So What Does Domino’s Pizza’s Balance Sheet Tell Us?

Net debt is 31% of Domino’s Pizza’s market cap. You’d want to be aware of this fact, but it doesn’t bother us.

The Bottom Line On Domino’s Pizza’s P/E Ratio

Domino’s Pizza’s P/E is 31.8 which is above average (17.7) in the US market. Its debt levels do not imperil its balance sheet and its EPS growth is very healthy indeed. So on this analysis a high P/E ratio seems reasonable.

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Domino’s Pizza may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.