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Should You Be Tempted To Sell Domino's Pizza, Inc. (NYSE:DPZ) Because Of Its P/E Ratio?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. 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. Domino's Pizza has a P/E ratio of 25.5 , based on the last twelve months. That means that at current prices, buyers pay $25.5 for every $1 in trailing yearly profits.

See our latest analysis for Domino's Pizza

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Domino's Pizza:

P/E of 25.5 = $236.2 รท $9.26 (Based on the year to June 2019.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

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

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (22) for companies in the hospitality industry is lower than Domino's Pizza's P/E.

NYSE:DPZ Price Estimation Relative to Market, August 16th 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. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling .

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

It's nice to see that Domino's Pizza grew EPS by a stonking 27% 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.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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 spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Domino's Pizza's Balance Sheet

Domino's Pizza's net debt equates to 34% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.

The Verdict On Domino's Pizza's P/E Ratio

Domino's Pizza has a P/E of 25.5. That's higher than the average in its market, which is 17. Its debt levels do not imperil its balance sheet and it is growing EPS strongly. Therefore, it's not particularly surprising that it has a above average P/E ratio.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

Of course you might be able to find a better stock than Domino's Pizza . So you may wish to see this free collection of other companies that have grown earnings strongly.

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.