Double-Digit Upside (or it's free) 🍕

In 2002, Sun Microsystem’s CEO Scott McNealy asked a straightforward question to investors who complained about the stock’s collapse during the dot com bubble:

“What were you thinking?”

His reason for asking this was rooted in the stock’s price to sales (P/S) valuation at the time, which was roughly 10x.

In order for investors to see any sort of return, fundamentally, from buying a company valued at 10x sales, management would have to pay you 100% of revenues for ten years straight.

Which just won’t happen, it’s financially impossible.

Over 50% of the S&P 500 trades at, or above, a 10x P/S multiple.

So today, I will start the first round of deep dives into the stocks I am excited to own in my portfolio (and why you should be as well).

And because Domino’s Pizza promised you wouldn’t pay if the pizza took longer than 30 minutes…

I’ll make you the same deal:

This idea is free.

If it delivers on double-digit returns, all I ask in return is that you become an Offside Premium member.

In there, you’ll have access to our other exclusive deep dives and deal pitches.

And most importantly,

Our coverage of the entire AI trade and why we believe Michael Burry is right in calling it a fraud.

Let’s get into Domino’s Pizza now.

As always, we’ll start the first day of this deep dive with a 30,000-foot overview of the entire landscape for Domino’s Pizza.

But before we start…

Here’s a free pitch deck made for you to download and keep handy as we go through a more detailed analysis of the business and its valuation, enjoy!

Warren Buffett, Peter Lynch, and other legendary value investors have helped generations of aspiring wealth builders with one of the simplest (and most powerful) pieces of advice:

Domino’s Pizza is one of those brands for me, and I can tell you the quality of the product is still the same as when I was a child.

In fact, I’ve made an effort to order the same pizza wherever my travels take me. Across Latin America, North America, Europe and Asia…

Domino’s still has its distinctive taste and quality.

Here’s why that matters more than ever in today’s environment:

Because cheese is where most pizza costs go, it’s important to track its prices in the futures market, since those will command margins for most pizza players in the space.

The Iran war has caused many commodities to go up in price, supply chain disruptions will do that.

Most companies will eventually start to choose between quality and margins, sacrificing product quality in order to retain their already-thin margins in a world where costs are going up.

However, as we’ll cover in part two of this deep-dive, Domino’s supply chain business is more than capable of “eating” these costs where other competitors (like Papa John’s or mom and pop pizza parlors) cannot. This is a direct moat to keeping quality and taste the same.

If it isn’t cheese and commodity prices, what then, is driving Domino’s Pizza to trade at 60% of its 52-week highs?

Year-to-year changes in Domino’s Pizza are mostly reliant on US retail sales numbers.

Which makes a lot of sense.

In plain English: 62% of the time, 60% of revenues follow changes in retail sales.

This is a problem since US consumer sentiment has just hit a new all-time low, so markets are falling into overly pessimistic expectations around discretionary spending on items like pizza.

But,

We all know that pizza is one of the items people lean on the most during financially tighter times, especially when there’s such low sentiment going on.

I believe you can take advantage of these low expectations around a depressed consumer, especially in a convenience like Pizza, and especially with Domino’s product pricing.

The very reason markets are selling consumer stocks is the same reason why you should consider buying Domino’s Pizza (and why we started buying last week).

On a per-inch basis, nobody beats Domino’s prices.

Except for Little Ceasar’s, but I don’t know anyone who enjoys their food.

If the consumer is that depressed and worried about their budgets, but pizza remains a convenience comfort food, then why can’t Domino’s win in this scenario?

You probably think of Domino’s as just another fast casual pizza brand.

But consider the following stat:

In essence, this brand is a distribution and logistics company that just happens to sell pizza at very low prices.

Let’s slow down for a minute because this is where it all gets a bit complex.

McDonald’s is the biggest and most profitable fast-food company in the world. The difference between them and your local burger joint is that McDonald’s is a real estate company that just happens to sell burgers and fries.

In other words,

Domino’s is the only pizza player that’s managed to crack a very tough business model in a very successful way.

Its margins and free cash flow growth speak for itself (see the comparison against PZZA above).

Here’s why the stock price doesn’t agree.

A common practice within the investment industry is to measure what your investments react against.

In the case of Domino’s, the stock is mostly reactive to breadth in the S&P 500, something that is missing right now.

Because this is a high-quality company with a strong profitability rate and balance sheet, it’s also reactive to the quality factor in the market.

80%+ of S&P 500 returns this past year came from speculative narratives and unrealized growth expectations, and markets are selling and ignoring other factors that aren’t attached to momentum and growth.

Here’s what that looks like in a chart:

Most notably, you can see how Domino’s is almost the mirror image to the value factor (because the market treats it like a growth stock).

Now we can come to a very clear conclusion here:

Markets are selling Domino’s stock because overly pessimistic consumer sentiment has spilled over onto overly pessimistic assumptions for the company’s growth.

That’s our expectations arbitrage opportunity, so I will end this Day one deep-dive with a take on the market’s expectations.

At a price of $315 per share, we can reverse engineer the market’s forecasts for Domino’s without having to build an overly complex discounted cash flow model.

Most investors will do the opposite, but I’ve found that a traditional DCF tells you more about the analyst than the underlying investment.

So let’s test what must happen for Domino’s to trade at $315:

As you can see, the expectations implied in today’s price are pretty bleak.

To justify a $315 share price, the next 15 years need to:

You and I can both agree these are some easy to beat expectations to say the least.

We also know what happens when companies beat revenue and EPS expectations…

In Day 2, we will dive deeper into what drives Domino’s financials, and what forecasts seem more reasonable.

After that’s covered, you’ll realize the company’s true value is much higher than today’s price.

See you in Day 2 of Domino’s Pizza deep dive.

Until next time,

OFFSIDE RESEARCH

Against the Tape, Ahead of the Curve.