Warren Buffett's investment success is hard to ignore, given the massive price increase of his primary investment vehicle, Berkshire Hathaway (BRK.A -0.39%) (BRK.B -0.56%). This is why every new Buffett stock acquisition gets huge attention on Wall Street. One of the most recent additions was Domino's Pizza (DPZ -0.69%). Here are three things investors need to know before running out and buying this restaurant chain's shares just because Buffett bought it.
1. Warren Buffett isn't always right
Successful investors on Wall Street are often viewed as having magical powers. To that end, Buffett's nickname is the Oracle of Omaha. That can lead smaller investors to put people like Warren Buffett on a pedestal that they may only partially deserve. Yes, Buffett's successes have built huge amounts of wealth. But he is still a human being, and he makes mistakes.
Image source: The Motley Fool.
As an example, Buffett backed the merger of Kraft and Heinz to form Kraft Heinz. The original plan was for it to be run by investment firm 3G Capital, which partnered with Buffett on the merger and had a history of successfully cutting costs to boost profitability at stodgy old companies. That plan didn't work out as well as hoped, 3G Capital is now out of the picture, and Kraft Heinz is working on a new approach. The stock has lost around two-thirds of its value since the tie-up in mid-2015.
That's just one example -- there are others. In fact, Buffett himself often points out his mistakes in Berkshire Hathaway's annual reports. Yes, he is a good investor overall, and his portfolio is filled with stocks that have been huge winners. But he isn't perfect. There are losers in the mix, too. Just because he, or one of his associates, buys a company for Berkshire Hathaway doesn't mean you should. It might not work out as planned, or it might not be an appropriate stock for your portfolio because it doesn't mesh with your style of investing.
2. Domino's Pizza isn't cheap
One of the core aspects of Buffett's approach is to try to buy great companies at an attractive price. It doesn't look like Domino's is totally in line with that standard.
For starters, the price-to-earnings (P/E) ratio is around 28 right now. That's only a little below the company's five-year average of 30, and roughly in line with the P/E of the broader consumer discretionary sector (using the Consumer Discretionary Select Sector SPDR ETF as a proxy). It is also about the same level as the S&P 500 index, which is trading near all-time highs. "Fairly priced" may be an appropriate description, but "cheap" certainly is not.
It's true that the business is performing well in some ways right now. For example, Domino's same-store sales in the United States rose a solid 3% in the third quarter and were up 4.5% through the first three quarters of this year.
However, the third quarter of 2023 saw same-store sales in the U.S. market decline 0.6%, and that figure rose just 1% through the first nine months of 2023. So 2024 results are coming off a low base, and it's pretty clear that what goes up can also go down.
To highlight that fact, same-store sales in the international market, where Domino's Pizza has more stores, were up just 0.8% in Q3 2024, down from 3.3% in the same quarter of 2023. Given that Domino's valuation is similar to the market, which is near all-time highs, investors might be pricing in too much good news for a business that can be highly variable over time. And don't forget that the restaurant industry is highly competitive.
3. Domino's is huge, and moving the needle could be hard
Domino's Pizza has around 6,900 U.S. locations and another 14,000 foreign restaurants. Altogether, it has well over 20,000 locations. That's a very large number, and it changes the game for a restaurant company like Domino's Pizza.
There are usually two ways that restaurants grow. The first is through opening new locations, while the second is by luring more customers into its existing locations (which is what same-store sales measures). Domino's Pizza opened a net total of 72 new locations in Q3 2024 (there were 208 openings and 136 closures). Over the past year it opened 805 stores, which is 4% growth year over year.
However, the openings in the third quarter amounted to less than half a percentage point of growth. It will require massive investment of time, energy, and money for store openings to keep driving the top and bottom line, which the Q3 slowdown hints could be hard to achieve.
That leaves same-store sales as the more important driver of financial success. But, as highlighted above, fickle customers can render that key metric highly volatile. Buffett could have jumped aboard at the perfect time, it's always possible. But it is also just as possible that Domino's Pizza will stumble if people decide that its pizza isn't so great anymore. Given the intense competition in the restaurant sector, there's probably more risk here than many investors realize.
Don't just follow anyone
Buffett often laments how investors act like lemmings, unthinkingly following hot fads and trends. One of his many pithy quotes is: "A pack of lemmings looks like a group of rugged individualists compared with Wall Street when it gets a concept in its teeth." Yet, in an ironic twist, Wall Street buys the stocks Buffett buys with lemming-like consistency.
There's no harm in researching the stocks Buffett buys for Berkshire Hathaway. But make sure you only buy the ones that make sense to you. That list may or may not include Domino's Pizza, but there are some very clear reasons to be skeptical of this recent purchase if you take the time to look.
