Darden Restaurants Eating Up The Competition

04/17/09 01:19:26 PM

by Donald W. Pendergast, Jr.

Shares of Darden Restaurants, the world's largest full-service restaurant chain, have risen more than 190% since making a major low in November 2008. The current technicals and fundamentals suggest even more gains may be in store for this stock.

Security: DRI
Position: Buy

Darden Restaurants, Inc. (DRI), based in Orlando FL, operates an enormous number of restaurant chains, with names like Red Lobster, Olive Garden, Longhorn Steakhouse, and Capital Grille, among others. Apparently, the recession of 2007-09 has done little to dampen the public's enthusiasm for casual dining, no matter how poorly the economy may be performing. DRI appears to be firing on all cylinders, what with a price/earnings ratio of 13.94, an annual dividend yield of 2.18%, and a steadily rising earnings growth trend.
And even though the stock has made an enormous move up from the broad market's reversal low made on November 21, 2008, a number of technical factors are implying that DRI may be about to embark on yet another upleg. Let's check out DRI's daily graph as seen in Figure 1 and see if we can identify a long trade opportunity or two.

FIGURE 1: DRI, DAILY. Sometimes, "buy high, sell higher" makes a lot of sense. The current mix of bullish technicals and fundamentals that have driven Darden shares up so quickly still appear to have plenty of momentum backing them up. Graphic provided by: MetaStock.

Graphic provided by: MetaStock.

Buy high and sell higher: Even though that can be difficult to do, emotionally, let's face it, when a stock has massive technical momentum and a solid earnings growth foundation, sometimes it's actually the safest way to trade. Momentum begets more momentum, which draws in more buyers at ever-higher prices -- up to a point, one that has not apparently yet been reached in DRI's shares. Technically, DRI has a lot going for it; the stock made a successful support test after a massive bullish breakaway gap, the August 2008 high of $37.83 was taken out four days ago, a new 55-day channel breakout has just been confirmed (a channel breakout parameter used by many longer-term trend followers in stocks and commodities), the accumulation-distribution indicator (bottom of chart) features an exceptionally bullish uptrend, and the stock has exceptionally high relative strength versus all of the major US broad market indexes. This is not a trend move to stand in front of no matter what any number of overbought technical oscillators may be screaming right about now.

Playing this move in DRI should be relatively straightforward; those convinced of immediate bullish follow-through may wish to put on a full position just above today's high, using April 15's low at $35.52 as an initial stop. If the stock rises, then use the (2 * 10 ATR) volatility trailing-stop (blue dots on chart) to help lock in any profits. Since the next major overhead resistance for DRI doesn't kick in until the $45 area, this trade has a favorable risk-reward ratio, especially considering the impressive slate of technical and fundamental factors that are currently driving this stock higher. More conservative traders might wait for a modest 30-minute chart pullback to put on half their position, loading on the rest on a break of today's high near $39.12.

Covered-call aficionados might also like to play the monster momentum in DRI; the current implied volatility in DRI calls is well above the average of the past two years, and an "ATM" (at-the-money, or close to it) $38 call can be sold for about $2.50, thus reducing the cost of ownership of 100 shares from about $3,854 down to $3,604. If the stock is called away at May expiration (28 calendar days), this covered-call trade will yield approximately 63% on an annualized basis. If the stock falters, closing below the trailing-stop, consider closing out the entire trade; no matter what happens here, the losses are likely to be modest on such a covered call, even if the trade stalls right out of the gate, stopping out quickly.

Solid earnings growth, high relative strength, and extremely bullish technicals can all help make the trauma of "buy high, sell higher" a lot easier. If you're right about such long channel breakout trade setups, the joy of winning and then taking substantial profits should easily outweigh the temporary discomfort of buying at a price where it might normally seem more natural to be considering a possible sale. Such are the paradoxes of the trader's everyday existence, and such paradoxes might just explain why there are so few consistently successful traders and investors.

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title:	Writer, market consultant
Company:	Linear Trading Systems LLC
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