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Has the Domino’s Pizza Enterprises Ltd share price run too hard?

In the long-term the share price performance of a stock should roughly reflect the earnings performance of a company, it’s for this reason that long-term investing works as patient investors can acquire a stock knowing that one day in the future it should trade at their calculation of fair value.

10 years ago, Domino’s Pizza Enterprises Ltd (ASX: DMP) had revenues of $144.5 million, net profit (before abnormals) of $13 million, earnings per share (EPS) of 20.4 cents per share (cps) and paid dividends totalling 10.4 cps.

Fast forward 10 years to 30 June 2015 and Domino’s reported revenues of $647 million, profits of $64 million, EPS of 72.8 cps and dividends totalling 51.8 cps.

The critically important number here is EPS as this takes into account the approximate 24 million in extra shares which have been issued over the decade. For the 10 years the total growth in EPS is 257% – a sensational result especially when considering that the net debt to equity ratio has declined in that time from 55.6% to 40.9%.

Meanwhile, the share price has increased from around $3 ten years ago to around $40 (today it is closer to $48) – that’s growth totalling around 1,200%!

So, what’s caused the discrepancy?

The significant outperformance of the share price compared with the earnings performance is due to what is generally referred to as “multiple expansion”. What this means is that a decade ago investors were willing to pay a price-to-earnings multiple of around 16 times trailing earnings for the stock, whereas at today’s price, investors are paying something closer to 60 times!

For conservative investors, Domino’s share price today will be hard to justify, however investors, who can foresee very strong growth over the next few years for the pizza chain may still like the stock.

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Motley Fool contributor Tim McArthur has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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