Profitable, cash-generating businesses that simply grow bigger are quite capable of delivering outstanding returns for investors. Domino's Pizza (LSE: DOM) is an example of a company that has done just that.
Today, I'm looking at Domino's and another success story -- easyJet(LSE: EZJ) -- with a view to identifying the qualities possessed by top growth companies generally, as well as deciding whether the shares of these two in particular are still worth buying today.
Delivering top returns
Domino's was floated in 1999 at 50p a share so a £10,000 investment would have got you 20,000 shares. After a 3.2-for-1 share split in 2007 and a further 3-for-1 split this year you would now own 192,000 shares. And your original £10,000 investment would be worth £672,000 at a current share price of 350p.
When Domino's joined the stock market it was already the leading UK home delivery pizza brand by sales. It had made a £1.1m profit on turnover of £20.7m in its previous financial year and at the flotation price the trailing price-to-earnings (P/E) ratio was 20.9.
As the market leader in its niche, Domino's was well placed to capitalise on the demographic factors it identified in its stock market admission document: "In particular, longer working days and the increase in dual career households have led to the rapid growth in the demand for freshly cooked delivered food. Pizza also has a wide appeal to younger age groups and as this population ages they are likely to retain similar tastes and pass these on to their children, thereby expanding this segment of the market."
Domino's couldn't have been more right about this and its turnover has grown from £20.7m to £317m in less than 20 years. In addition to top-line growth, there has been a hugely positive effect on the profit margin and return on equity (ROE) from the increasing scale of this franchise-model business. The profit margin and ROE have averaged 20% and 58% respectively for the last five years.
Domino's trailing P/E today is 29.4, compared with 20.9 at flotation, and I don't expect earnings growth to continue at the rate seen in the past. Nevertheless, margins and ROE mark this as a high quality business and I believe the shares are still worth buying today.
Decent enough but...
easyJet joined the stock market in 2000, a year after Domino's. A £10,000 investment at the flotation price of 310p would have netted you 3,226 shares, although this would have been reduced to 2,957 after an 11-for-12 share consolidation in 2012. Today, your original £10,000 investment would be worth £29,274 at a share price of 990p.
easyJet has been a successful business but while its top-line growth has matched Domino's, it hasn't delivered the same level of margin expansion and ROE as the pizza group. easyJet's profit margin and ROE have averaged 11.5% and 15.7% respectively for the last five years, compared with Domino's 20% and 58%.
easyJet is on a cheap P/E of 9.1 and is a decent enough business. However, it operates in a capital-intensive, competitive and cyclical industry. I don't believe such areas of the market are an attractive hunting ground for the kind of shareholder returns that have been delivered by Domino's.
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G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended Domino's Pizza. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.