Dunkin Brands Group Inc (NASDAQ: DNKN), a consumer discretionary company with a market capitalization of $5.0 billion, currently trades at a P/E multiple of 14.2x which is below the sector’s median multiple of 18.8x. Although this makes DNKN look attractive, investors may change their mind after reviewing the assumptions behind the P/E ratio. In the post below, I explain how to apply P/E multiples and what to watch out for.
How To Utilize Dunkin’s PE Multiples
A multiples valuation, also known as a comparable companies analysis, determines the value of a subject company by benchmarking the subject’s financial performance against companies deemed to be similar. We can then determine if a company is undervalued or overvalued relative to its peers by comparing metrics like growth, profit margin, and valuation multiples.
A P/E Ratio is a valuation metric that indicates the multiple of earnings investors are willing to pay for one share of a company:
P/E Ratio = Stock Price ÷ Earnings Per Share
The P/E ratio by itself is not very helpful at all. It is only useful when comparing it to other companies that are considered similar to the subject company. The basic idea is that companies with similar characteristics should trade at similar multiples, all other things being equal. Therefore, we can come to a conclusion about the stock if the ratios are different. In the chart below, I compare Dunkin’s P/E ratio to its peer group that includes Chipotle Mexican Grill, Inc. (NYSE: CMG), McDonald’s Corporation (NYSE: MCD), Biglari Holdings Inc. (NYSE: BH) and Ruby Tuesday, Inc. (NYSE: RT).
Since Dunkin’s P/E ratio of 14.2x is lower than the median of its peers (24.7x), it means that investors are paying less than they should for each dollar of DNKN’s earnings. As such, our analysis shows that DNKN represents an undervalued stock. Furthermore, finbox.io’s P/E Ratio Model calculates a fair value of $81.65 per share which implies 35.6% upside.
I selected a fair multiple of 19.2x in my analysis by averaging Dunkin’s current P/E ratio with its peer group and sector.
The P/E Ratio’s Flaws
While this approach typically provides a reasonable valuation range, it is important to understand that our conclusion rests on some important assumptions. The first being that the selected peer group actually contains companies that truly are similar to Dunkin. The second important assumption is that the selected peer group stocks are being fairly valued by the market.
If the assumptions above do not hold to be true, then the difference in P/E ratios could be due to a variety of factors. For example, if you accidentally compare Dunkin with higher growth companies, then its P/E multiple would naturally be lower than its peers since investors reward high growth stocks with a higher price.
source: P/E model
On the other hand, if the second assumption does not hold true, Dunkin’s lower multiple may be because our selected comparable companies are being overvalued by the market.
What To Do Next
As a current investor, you may have already conducted fundamental analysis on the company and its stock so its current undervaluation could signal a potential buying opportunity to increase your position in DNKN. But keep in mind the P/E ratio’s potential flaws when applying this valuation approach. It is important to note that there are a variety of other fundamental factors that I have not taken into consideration in this article. I highly recommend that you continue your research on Dunkin by taking a look at the following:
Valuation Metrics: how much upside do shares of Dunkin have based on Wall Street’s consensus price target? Take a look at our analyst upside data explorer that compares the company’s upside relative to its peers.
Risk Metrics: how is Dunkin’s financial health? Find out by viewing our financial leverage data metric which plots the dollars in total assets for each dollar of common equity over time.
Efficiency Metrics: is management becoming more or less efficient over time? Find out by analyzing the company’s asset turnover ratio which measures the dollars in revenue a company generates per dollar of assets.
Author: Matt Hogan
Expertise: Valuation, financial statement analysis
Matt Hogan is also a co-founder of finbox.io. His expertise is in investment decision making. Prior to finbox.io, Matt worked for an investment banking group providing fairness opinions in connection to stock acquisitions. He spent much of his time building valuation models to help clients determine an asset’s fair value. He believes that these same valuation models should be used by all investors before buying or selling a stock.
Matt can be reached at firstname.lastname@example.org.
As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.