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I Love the Risk/Reward on This American Favorite

Dunkin' Brands Group (NASDAQ: DNKN) has far outpaced the performance of the S&P year to date, gaining nearly 48% while the major index has risen about 26%.

Even more exciting is that if the shares can crack round number resistance at $50, they are likely to challenge $60 in fairly short order. Since there is a well defined stop-loss level at the major uptrend line, which intersects the chart just under $46, the reward-to-risk ratio is roughly 2.5:1, which is highly attractive.

Dunkin' Donuts -- which has been around since 1950 -- is an American favorite. Through aggressive expansion, it is capturing an even larger domestic and international following.

In the most recently reported third quarter, the company, which also owns the Baskin-Robbins brand, added 222 new stores worldwide, 81 of which were new U.S.-based Dunkin' Donuts locations. There are now 7,500 Dunkin' Donuts restaurants in the U.S.

CEO Nigel Travis announced intentions of ultimately opening at least "15,000 Dunkin' Donuts restaurants in the U.S., including approximately an additional 3,000 east of the Mississippi and 5,000 in the western part of the country."  

That's double the size of the current chain. At present, DNKN is heavily situated in the eastern United States, so there is a lot of virgin territory that can be easily conquered.

In the third quarter, the first Colorado-based Dunkin' Donuts locations were opened. The company also signed development agreements in Southern California, bringing the total number of planned outlets there to 70. During this same period, the restaurant's U.S.-based same-store-sales increased 4.2%, revenue increased 8.5% from a year ago, and earnings increased at a double-digit clip (10.8%).

Since the stores are almost entirely operated by franchisees, continued expansion should mean an influx of franchise fees and royalty income, along with minimal operating expenses. That's a formula for strong future profit growth.

The chart is strong to say the least. Since its July 2011 IPO near $19, the stock has been on a highly bullish run and shows no sign of slowing down.

DNKN Stock Chart

Shares nearly doubled within a year of the IPO, hitting an all-time high above $36 in June 2012. From there, they pulled back, falling to an August 2012 low below $28.

DNKN bounced off this level, stalled and found a slightly higher low in November 2012 just below $29. A "W" shape can be detected during the period from July 2012 to the end of the calendar year.

In January, resistance was pierced with DNKN rising to a new high, and since that time, shares have since hit a series of consecutive all-time highs. A major uptrend line can be drawn from the November 2012 bottom. This line currently intersects the chart just under $46 a share and, as I mentioned above, provides a clear stop-loss point. 

DNKN is currently trading near its all-time high of $49.40, which was made in late October. However, for the past three weeks, shares have been unable to break this level, creating a small shelf of resistance. It is not unusual for a stock to find resistance at a round number, in this case $50.

If the stock can penetrate $50, the next round number resistance would be $60. That means the trader would have about $10 of upside potential if the shares were bought just above $50, but only about $4 of risk before the stop loss was hit. By waiting to take a position until $50 resistance is broken, the trader can enter a low-risk, potentially high-reward trade.

The bullish technical outlook is supported by strong fundamentals.

Due to rising demand, driven by domestic and international expansion, analysts project fourth-quarter revenue will increase 10.6% to $178.78 million from $161.7 million in the year-ago quarter.

For the full 2013 year, analysts expect increased franchise fees and renewals will help drive revenue 7.9% higher to $709.96 million from $658.18 million last year. And 2014 revenue is estimated to increase 7.2% to $760.78 million.

The earnings outlook is similarly strong.

Analysts project fourth-quarter earnings will increase almost 18% to $0.40 per share from $0.34 in the comparable year-earlier quarter. For the full 2013 year, analysts expect earnings will also increase 18% to $1.51 per share from $1.28 last year. And 2014 earnings are estimated to rise 19% to $1.80 per share.

In addition, the company rewards traders with an annual dividend of $0.76 per share, for a yield of 1.6%. Since beginning a dividend in March 2012, management has increased the annual payout by $0.16. Given the company's strong financial performance, the future yield will likely continue to rise.

Risks to consider: Part of Dunkin' Brands' expansion plan is to open at least 1,000 new restaurants in California. However, the state is already filled with coffee outlets, especially Starbucks (NASDAQ: SBUX). In fact, there are more Starbucks in California than any other state. Nevertheless, the two coffee chains appeal to different demographics and income classes.

Recommended Trade Setup:

-- Buy DNKN at $50.19, above $50 round number resistance
-- Set stop-loss at $45.79, just below major support
-- Set initial price target at $59.95 for a potential 19% gain by mid-2014