Domino's Pizza (DPZ) could raise its dividend rate next month, as its strong free cash flow (FCF) can finance this. This will likely push DPZ higher based on its historical dividend yield.  

DPZ stock closed at $427.35 on Friday, Jan. 17, and well off its recent peak at $476.19 on Nov. 29.  However, it could be worth over 16% more at close to $500 per share. 

One reason is the pizza company's strong FCF and FCF margins can easily afford a 16% dividend per share (DPS) hike. 

Based on its historical dividend yield of 1.40%, DPZ stock could be worth at least $500 per share. This article will show how this works.

Moreover, traders see short-put option plays to generate extra income for existing shareholders.

Dividend Hike Likely

On Nov. 15, I discussed how Domino's Pizza generated strong free cash flow (FCF) and FCF margins: “Is Domino's Pizza Stock Worth Buying? Buffett Likes Its Huge Free Cash Flow.”

For example, last quarter, 13.5% of the company's Q3 sales turned into FCF. That was much higher than last year's 6.1% FCF margin. 

Moreover, YTD its FCF was $376 million, or 11.5% of sales, vs. $362.9 million, or 11.8% of sales last year. Therefore, if Domino's Pizza generates at least $200 million in FCF during Q4, its total FCF for the year would be $576 million. That would be 12.1% of estimated 2024 sales of $4.75 billion.

Analysts now forecast 6.1% sales growth in 2025 to $5.04 billion. Therefore, if Domino's can maintain a 13.5% FCF margin, it will generate:

   0.135 x $5,040 million = $680.4 million FCF

That would be an increase of over $100 million in FCF this year, or +18.1% growth:

   $680.4m ‘25 est. FCF /$576m ’24 est. FCF = 1.181

Moreover, this 2025 FCF is well over the amount of its dividend costs. Here's why. 

At its present $6.04 dividend per share (DPS), with 34.5 million shares outstanding, the dividend cost is:

    $6.04 DPS x 34.5m shs o/s = $208.38 million dividend cost

So, the $680.4 million in est. FCF is well over the $208 million dividend cost.

DPZ Stock Value Based on Dividend Yield

For example, let's assume that the board raises the annual DPS to $7.00, or 15.89% higher than the present $6.04 DPS rate. First, let's see if that is possible, and then what would happen.

Affordable. As shown above FCF this year could end up being 18% higher if the company continues to generate 13.5% FCF margins.

Moreover, the dividend cost would only be $241.5 million (i.e., $208.38m div. cost x 1.1589).

That is still less than half of the estimated $680.4 million in FCF this year.

So, what would happen to the DPZ stock price?

What Would Happen? Historically, DPZ has had a 0.96% dividend yield, according to Morningstar, over the past 5 years. Moreover, in the last 12 months, its average yield has been 1.41%.

But today, its yield is much higher than its past average:

   $6.04 DPS / $427.35 = 1.41%

So, even if the stock were to trade at its historical yield, DPZ would be much higher:

   $6.04 / 0.0096 = $629.17

That is 47% higher than today's price of $427.35.

Just to be conservative, let's use a 1.40% yield average and apply it to the estimated $7.00 DPS:

  $7.00 / 0.0140 = $500.00 per share

That is 17% higher than today's price. In other words, the stock could easily rise 17% to $500 over the next year based on its historical yield.

One way to play this, especially for existing shareholders, is to sell short out-of-the-money (OTM) puts in nearby expiry periods.

Shorting OTM Puts

I discussed this play in a recent Barchart article on Dec. 10: “Domino's Pizza Looks Attractive to Value Buyers and Short-Put Investors.”

At the time DPZ was at $457.12, and I discussed selling short the $440 strike price put option expiring on Jan. 10, for a premium of $5.50. That provided the investor an immediate yield of 1.25% (i.e., $5.50/$440). (In the Nov. 15 article, I also discussed selling short the $420 strike price put for $4.40.)

As it turned out, DPZ closed at $402.33 on Jan. 10. So, the investor would have been assigned to buy shares at $440. 

However, note that over the last two trades, the investor has accumulated $9.90 in income. So their breakeven would have been $440-$9.90, or $430.10, which is close to today's price.

Moreover, the investor now owns 100 shares and can sell out-of-the-money (OTM) calls on these shares. Moreover, the investor can use the margin from this holding to sell short new OTM puts.

For example, look at the Feb. 14 expiry period. It shows that the midprice of the $420 put option strike price is $5.75.

That provides a cash-secured short-put investor an immediate yield of 1.369% (i.e., $5.75/$420.00 = 0.01369).

So, now the investor (even without selling covered calls) has a breakeven price of $424.35 (i.e., $430.10 - $5.75). Not only is that lower than today's trading price, but if the DPS rises to $7.00 the investor would have a higher yield.

For example, if DPZ stays over $420 by Feb. 14, the investor's basis would be $424.35 and the $7.00 DPS would give the investor an annual yield of 1.649%.

In addition, if the investor keeps selling short OTM puts and making 1.369% each month like this trade, the expected return (ER) could be +16.428%. And, in addition, by owning shares in DPZ, if it rises to the $500 target price the investor could make another 17%.

The bottom line is that DPZ stock looks cheap here based on its strong free cash flow. If the company hikes its dividend per share to $7.00 next month, the investor could make a good return.

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.