Domino's Pizza, Inc.'s (NYSE:DPZ) price-to-earnings (or "P/E") ratio of 24.9x 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. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.
Domino's Pizza certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. 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.
Taking a look back first, we see that the company grew earnings per share by an impressive 23% last year. The latest three year period has also seen an excellent 30% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 7.6% each year over the next three years. That's shaping up to be materially lower than the 10% per annum growth forecast for the broader market.
In light of this, it's alarming that Domino's Pizza's P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. 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.
What We Can Learn From Domino's Pizza's P/E?
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've established that Domino's Pizza currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
Having said that, be aware Domino's Pizza is showing 2 warning signs in our investment analysis, you should know about.
If you're unsure about the strength of Domino's Pizza's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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