Take a look at the Domino's Pizza Enterprises Ltd. (ASX: DMP) share price over the past 10 years.
Domino's (DMP) Share Price
It's almost unbelievable. The 1,500% Domino's share price gain (remember that does not include dividends) turns $10k in $150,000. And to think that return began right before the global financial crisis (GFC).
Here's what the Domino's share price looks like over six months:
Will the Domino Effect Continue?
While a six-month fall of 18% hurts — a lot — it is not enough to suggest the downtrend will continue. We need to focus on the business to draw a conclusion like that.
However, the most obvious concern for shareholders and investors is the price of Domino's' shares. Even if we factor in analyst projections for a 30% rise in profits, the company's shares are still trading on a forward price to earnings (P/E) multiple of 43 times. For the record, that's like growing a business 30% in just one year!
Fingers crossed, huh.
Using forecasts of 2019 profits, which are far far far more unlikely to be accurate, the company's P/E is 26 times. Shares in CSL Limited (ASX: CSL), a hugely successful biopharmaceutical giant selling life saving products, trade at 29 times next year's profits and pay a bigger dividend.
If it don't make sense, it won't make dollars
Given where we could be in the market cycle, I wouldn't take a slice of the Domino's pizza (pun intended), simply due to valuation concerns.
Remember, you don't need to value a company's shares to the nth degree. What's important is that when you sell your shares the market is willing to pay more for them than you did. Ideally, the sale (or 'exit') price is enough to give you a double-digit annualised return.
Think how much the company's profit would have to grow, and the price of the shares relative to profit now, factoring in the market average P/E of 16x in the future. To make it worthwhile, the 'exit price' must be huge!
Foolish Takeaway
Domino's has been a wildly successful business selling a commoditised product. But it doesn't pass the best investment checklist ever created:
- Is the business easily understood? Yes.
- Does it have an enduring competitive advantage? No.
- Does management operate with integrity and talent? Yes.
- Does the share price make sense? No.
In case you are wondering, the greatest investor to ever live, Warren Buffett, and his partner Charlie Munger created that list. There's a reason why they are some of the richest people alive.
And it's not because they made excuses for companies that didn't pass the checklist.
