Popular Stock Just $1 Away From a Breakout
One of the most explosive formations in technical analysis is called the “flag.”
The pattern consists of a nearly straight-up price advance followed by a consolidation, which usually takes the form of a pennant or small rectangle.
Technical analysis holds that a stock typically leaves a consolidation formation in the same direction as it enters. Since the flag begins with an explosive move higher, the odds of shares breaking out to the upside are high.
That’s particularly true when the underlying company has a robust fundamental outlook, like today’s trade, Domino’s Pizza (NYSE: DPZ).
In late February, Domino’s reported stellar fourth-quarter results. Revenue increased 15% to $741.2 million, fueled by an 11% increase in domestic same-store sales. That translated to earnings of $1.15 per share, which beat Wall Street’s consensus by $0.05.
Shares responded by jumping 13% in one day (the flagpole) and then consolidating in a narrow rectangle (the flag).
We’ll dig deeper into the chart in a moment. But first, let’s explore three fundamental factors that support our bullish view of the stock.
1. An Innovative, Tech-Savvy Company
Domino’s focus may be on making pizza, but it’s not sleeping on the tech front. The company is more than just mobile-friendly (which is almost a given these days); it’s also developing innovative technologies to acquire customers and deliver its products.
Domino’s encourages customers to place orders on everything from smart TVs to smart watches. Customers can even place an order through Twitter (NYSE: TWTR) using popular emojis. And, of course, less tech-savvy customers can still call or use a computer to order.
These options speak to new generations, differentiate Domino’s from other pizza joints and offer customers the opportunity to place their order anytime, anywhere, any way… which, in turn, helps drive sales.
In 2015, global digital sales, which include sales at company-owned and franchise locations, topped $4.7 billion. And roughly half of Domino’s U.S. sales were through digital, online or mobile platforms last year.
Another example of the company’s innovation is its recent debut of an “oven car.” The custom-designed vehicle, released in select cities, features an on-board oven, which keep pizzas warm en route on deliveries.
As Domino’s continues to innovate and cater to its customers’ digital needs, sales should continue to grow.
2. Declining Cheese Costs
An oversupply of milk has led to falling dairy prices, which is great news for Domino’s bottom line. Since cheese is a key ingredient in pizza, it is a large cost for the company.
In fact, Domino’s management noted this as a driver of strong fourth-quarter profits, saying they saved over $15 million in ingredient costs thanks largely to cheap cheese.
These savings are likely to continue as analysts following the dairy industry anticipate continued weakness in prices throughout 2016.
3. Growing International Exposure
Domino’s is a global enterprise with over 12,500 stores spread across 80 international markets. Of the $9.9 billion in global retail sales (company-owned and franchised) reported in 2015, almost half — $5.1 billion — were international sales thanks to continued growth across the globe.
In the most recent earnings report, the company saw international same-store sales grow 8.6% year over year in Q4 and 7.8% annually. This marked the 88th consecutive quarter and 22nd consecutive full year of positive international same-store sales growth.
Last year, Dominos opened a record 768 new international outlets. In coming years, management plans to open over 10,000 new stores worldwide, with India, China and Europe the main targets.
In 2015, Domino’s opened its 900th store in India. Considering the country has a population of over 1.3 billion people, that leaves plenty of room for more locations.
Domino’s is also in the early stages of its push into China with just 60 or so stores. Investment firm Maxim Group estimates that number could jump to 1,800 over the next 15 years.
And the company is taking aggressive steps in Europe, especially in Germany, recently acquiring the country’s largest pizza chain, Joey’s.
Continued expansion should help keep international sales growing in the months and years to come.
Results for the current quarter are scheduled to be reported on April 28, and analysts expect revenue to grow 8% to $544.3 million, while earnings are estimated to jump 21% to $0.98 per share.
For the full year, management expects global retail sales (company-owned and franchised) to grow between 7% and 11%. And analysts are forecasting earnings growth of 21% on an 8% increase in total revenue.
That’s a strong fundamental backdrop for DPZ to break out of its flag formation.
The stock has gained almost 20% year to date — compared with a 3% loss for the broader market — and should move even higher once its consolidation period ends.
As you can see on the chart, DPZ made a double-bottom just under $70 in mid-2014. Shares then shot up over 70% in a year.
After peaking just below $120 in July of 2015, DPZ began a prolonged sideways consolidation that saw the stock break its major uptrend line but repeatedly find support near $100.
Late last month, shares surged through resistance on about twice their average trading volume after the company’s better-than-expected Q4 earnings report.
The “flagpole” of DPZ’s flag pattern was formed by this one-day rally from $118 to $133, in round numbers. The stock is now in the process of a rectangular consolidation, moving sideways in a narrow range between $130 and $134.
Once resistance near $134 is taken out, we expect shares to move rapidly higher. The measuring principle for a flag calculates a target by adding the height of the flagpole to the bottom of the consolidation.
The flagpole was approximately 15 points, so when added to the bottom of the range at $130, we get a minimum target of $145. However, flag formations often exceed their minimum objective, so we are setting our actual target just below round number resistance of $150, at $149.95
We’ll set our stop-loss just below the July 2015 peak of $119, at $118.85.
Recommended Trade Setup:
— Buy DPZ at the market price
— Set stop-loss at $118.85
— Set price target at $149.95 for a potential 13% gain by Q3
One last thing before you place your trade…
Right now, there are thousands of deposits being put down on DPZ by speculators, hedge funds and even some average investors, all of whom are waiting for their orders to be filled. But three-quarters of them never are and Wall Street simply collects the money. That is, unless you get to it first.
Last year, one trader intercepted more than $46,000 of these deposits, placing them directly into her account. She just put together a presentation to show average traders how they can do the same. Click here to access it before it comes down.