Is Domino's Pizza Stock Worth Buying? Buffett Likes Its Huge Free Cash Flow

Based on Berkshire Hathaway's new stake, Domino's Pizza (DPZ) stock looks attractive to value investors like Warren Buffett. Its huge free cash flow (FCF) and FCF margins may be why. One way to play it is to short out-of-the-money DPZ put options.

DPZ was at $432.89 on Friday, Nov. 15. Warren Buffett's company disclosed yesterday that it had taken a new position of 1.28 million shares in DPZ stock. That works out to roughly 3.7% of its 34.5 million shares outstanding at the end of the quarter.Based on its strong free cash flow (FCF) and FCF margins, DPZ stock could be worth 30% more at $563 per share. This article will explore how shorting out-of-the-money puts is a good way to play this.

Domino's Strong FCF and FCF Margins

Last month I highlighted DPZ stock in my Oct. 13 Barchart article, “Domino's Pizza Expands Its Free Cash Flow Margins - DPZ Stock is Worth 25% More.” I argued that DPZ stock was worth at least $537 per share. I argued this was based on its strong free cash flow (FCF) and FCF margins based on its next 12-month (NTM) average revenue forecasts.

Now I think it's worth even more at $563 per share.

The reason is that Domino's has been squeezing more cash out of its operations. For example, in Q3 its FCF margin on sales hit 13.5%, up from 9.5% in Q1 11.6% in Q2, and just 6.1% a year ago.

Domino's Pizza free cash flow margins - DPZ Q3 YTD earnings results and Hake analysis

As a result, I have decided to use analysts' 2025 revenue forecasts, rather than just NTM sales as in my prior target price method. Here is how that works.

Next year analysts expect sales will rise to $5.04 billion, up 6.1% from this year's forecast of $4.75 billion. But its FCF margin, if sustained at 13.5% in 2024, will substantially hike its FCF forecast over 2024 (an average of 11.5% expected).

   $5.04 b  2025 sales x 13.5% = $680 million in 2025 FCF

YTD in 2024 through Sept. 30, Domino's has made $376.1 million in FCF on sales of $3.2625 billion, or just 11.5%. FCF in Q4 2024 is forecast to reach $200 million with a 13.5% FCF margin, or $576.1 million for all of 2024. 

So, the 2025 FCF estimate is 18% higher: 

  $680m FCF 2025/ $576m FCF 2024 -1 = 0.18, i.e., +18% YoY

Moreover, its FCF margins could expand, since operating leverage expands cash flow with higher sales. As a result, DPZ stock could be worth substantially more. Let's see how.

Target Price for DPZ Stock

One way to value this stock is to use an FCF yield metric. This metric assumes that its dividend yield will be 3.50% if Domino's pays 100% of its FCF to shareholders.

Here is how that works out:

  $680m FCF 2025 / 0.035 = $19.43 billion market cap

Its market cap today, with 34.5 million shares outstanding is: 

   $432.89 x 34.5m = $14.93 billion market cap

So, $19.43b / $14.93b -1 = 0.301, i.e., +30% higher.

In other words, DPZ stock is worth $562.76 per share ($432.89 x 1.30).

One way to play this is to short out-of-the-money put options. That way you can set a lower buy-in target price and to gain income while waiting.

Shorting OTM Puts

For example, look at the December 13, 2024, expiration period, 28 days from now. It shows that the $420 put option strike price, over 4% below today's price, has a bid-side price of $4.40.

That gives the short-seller of these puts a 1.05% short-put yield (i.e., $4.40/$420.00). This is good for the next month, assuming DPZ stock does not fall to $420, or $12.89 below today's trading price.

DPZ puts expiring Dec. 13, 2024 - Barchart - As of Nov. 15, 2024

Moreover, even if that happens, these cash-secured puts allow the investor to have a lower buy-in breakeven. That is because although the investor has to first secure $42,000 in cash or buying power per contract short, they would also immediately receive $440 (i.e., $4.40 x 100 shares).

So, the net break-even cost per share would be $420-$4.40, or just $415.60. That is 4.0% below today's price. That is a good buy-in price. Moreover, an investor can repeat this play every three weeks if the stock stays over the strike price and then gain additional income.

The bottom line is that DPZ stock looks undervalued here and is now attracting value investors like Buffett. One way to play this to set a lower buy-in price and for income is to short out-of-the-money puts.

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On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.