Has Domino's Pizza Become the Perfect Stock?
Jul 19th 2012 9:57AM
Updated Jul 19th 2012 10:06AM
Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?
One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Domino's Pizza (NYS: DPZ) fits the bill.
The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:
- Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
- Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
- Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
- Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
- Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.
With those factors in mind, let's take a closer look at Domino's Pizza.
What We Want to See
Pass or Fail?
|Growth||5-year annual revenue growth > 15%||2.9%||Fail|
|1-year revenue growth > 12%||4.3%||Fail|
|Margins||Gross margin > 35%||28.7%||Fail|
|Net margin > 15%||6%||Fail|
|Balance sheet||Debt to equity < 50%||NM||NM|
|Current ratio > 1.3||1.16||Fail|
|Opportunities||Return on equity > 15%||NM||NM|
|Valuation||Normalized P/E < 20||20.17||Fail|
|Dividends||Current yield > 2%||0%||Fail|
|5-year dividend growth > 10%||0%||Fail|
|Total Score||0 out of 8|
Source: S&P Capital IQ. NM = not meaningful because of negative shareholder equity. Total score = number of passes.
Since we looked at Domino's Pizza last year, the company has lost its two remaining points. But the stock is up about 25% over the past year as the pizza chain's prospects have improved.
Pizza is big business, and Domino's is a big player in the space. But the company suffered from a negative perception of its pizzas. After even CEO Patrick Doyle said that the pizza maker's products weren't up to snuff, the company set out to make some big changes. With improvements in quality and taste among its existing offerings along with innovations from some expanded menu concepts, Domino's has come a long way.
But Domino's has further to go and hasn't gotten rid of its rivals in the hugely competitive pizza business. Yum! Brands' (NYS: YUM) Pizza Hut as well as Papa John's (NAS: PZZA) remain aggressive in the industry and will continue to counter Domino's moves to improve.
Just like McDonald's (NYS: MCD) and Starbucks (NAS: SBUX) have relied on international expansion for growth, Domino's best prospects are in outside the U.S., where overall economic growth is stronger. The company continues to see better growth potential in international markets.
Last quarter, though, Domino's didn't match up to investors' hopes. Domino's shares plunged as much as 14% even as adjusted earnings per share rose by 12%. A drop in revenue combined with some significant expenses from recapitalizing the company spooked investors, but same-store sales growth of 2% domestically and 4.7% internationally was a positive sign.
For Domino's to improve, it needs to work on cutting back on its debt load. Once the company has positive shareholder equity, it will be in a much better position to advance toward perfection.
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.
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At the time this article was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of McDonald's, Starbucks, and Papa John's. Motley Fool newsletter services have recommended buying shares of McDonald's and Starbucks, as well as writing covered calls on Starbucks. 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 Fool has a disclosure policy.
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