Why This Stock is Set to Generate Sky-High Returns

Introduction

Following the article about 4 generational buying opportunities, I'd like to delve into another great company that has generated a lot of alpha over the past decade, but is set to soar even more. We're still in an elevated VIX environment, meaning we have to first focus on the study I conducted regarding forward buy-and-hold returns for any VIX level. Let's focus on Domino's Pizza (NYSE: DPZ) in this piece. The company ranks among the best 9 stocks on our premium watchlist.

(Source: DOMINO'S PIZZA WEBSITE)


Domino's Pizza: What A Performance in High VIX Environments!

Based on my research from 2014 up until now, initiating a position in Domino's Pizza turns out to be extremely profitable in every market environment. However, the difference between buying into VIX strength (like we have right now) has proven to be even more lucrative, especially on a forward 6-month and 1-year basis.

(Source: Option Generator's Research)


Looking at the absolute returns does not tell us the complete story about whether or not to buy a stock. At Option Generator, we believe that the Sharpe Ratio is the most relevant metric to pay attention to. It indicates the amount of volatility, and thus consistency relative to the return. The higher this metric, the better the risk-reward profile. Domino's Pizza sports a Sharpe Ratio of 3.5 for 1-year forward returns if one buys into VIX strength (25+ %), significantly higher than the average 1.4.

(Source: Option Generator's Research)


Things get even better with the minimum returns for Domino's Pizza being noticeably positive after a spike in the VIX. So in essence, one would expect to see a very low chance of losing money on his/her DPZ investment after a spike in the VIX (25+ %).

(Source: Option Generator's Research)


Domino's Pizza is a Story of "Consistently Delivering on its Promises"

Relying on a rock-solid track record, Domino's Pizza has shown 36 consecutive quarters of positive US same store sales growth. Although the average growth rate slowed down to 3.2% in 2019 compared to an average 6.9% since 2010, it's still in line with the average run rate of 3.8% since 1997.

(Source: Domino's Pizza Investor Presentation)


Meanwhile, Domino's Pizza's EBITDA per franchisee continues to climb (from ~$700K in 2015 to ~$1.180M in 2019) as profit margins are still improving steadily. With its corona-proof business model and flexible pricing strategy, the company is ready to capitalize on the post-corona era and to continue to acquire market share in the QSR pizza industry where Domino's Pizza already holds a dominant position. Although store openings planned for 2020 are being delayed, the second quarter is showing hopeful signs with U.S. comparable sales rising ~7.1% YoY in the four weeks through April 19, 2020. Conversely, international retail sales have declined ~3.2% YoY during the three weeks up to April 12.

(Source: Domino's Pizza Investor Presentation)


The key driver behind Domino's Pizza's growth story is certainly market share acquisition. By the end of 2022, I believe Domino's Pizza will hold 42% market share in the pizza delivery market.

(Source: Domino's Pizza Investor Presentation, Option Generator's Graph)


Over the past years, a combination of both increasing market share and executing cost efficiency programs has lead to fast-growing free cash flows. Moreover, given DPZ's robust ROE and ROA of 25.7% and 24.1% respectively, management has generously tapped the bond market to repurchase stock. These actions helped push the free cash flow growth rate per share to even more incredible levels. Going forward, counting on a yearly 3% reduction in outstanding shares and yearly organic free cash flow growth of 12%-14% should lead to an estimated shareholder return of 15%-17%.

(Source: Domino's Pizza Financials, Option Generator's Graph)


Valuation

Based on ~$650 million in free cash flow by the end of 2022, shares are trading at a forward FCF yield of ~4.3% based on the current market cap. While that does not seem appealing at first sight, buying DPZ means you're adding a generational elite-performer with consistent cash flow growth to your portfolio. Its management should be praised for its smart capital allocation decisions and outstanding track record.

(Source: Domino's Pizza Investor Presentation, Option Generator's Graph)


Technical Analysis: Monthly Chart

After 1.5 years of consolidation, shares have now powerfully broken out. There's a very good chance that we see the $420 threshold over the next couple of weeks before setting a long-term bottom at ~$400. The directional movement index has been uninterruptedly positive since 2010, while the MACD saw an up-cross at the beginning of year. The latter acts as a mid-term impulse to the long-term uptrend.

(Source: Pro Real Time)


Covered Call Writing

Just like with Service Now, I highly recommend buying Domino's Pizza and selling covered calls to reduce your breakeven point and thus risk. In normal market conditions, selling 3% out-of-the-money covered calls on DPZ yields 2.5%-3.0% on a monthly basis. By staying mechanical and following our script of portfolio overwriting, the odds of long-term investment success will be thrown significantly into our favor.

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