Serving Up A Slice Of Tasty Profits

 |  Includes: DPZ, RAVE
by: Joshua Hayes

The stock market finally staged a legitimate Follow-Through Day on Tuesday with the Nadaq (NASDAQ:QQQ) and S&P 500 (NYSEARCA:SPY) rallying over 1.5% on higher volume than the day before. Historically, no stock market uptrend has ever started without a Follow-Through Day. However, not every Follow-Through Day leads to a new stock market rally. While one out of four Follow-Through Days will work it is still always a good idea to invest with the market, cutting your losses quickly if the market proves we are wrong.

Identifying the new leaders of a possible new uptrend involves searching for the stocks that held up the best during the market pullback, and are exploding higher on the Follow-Through Day. Today two delicious stocks clearly caught my attention on that end.

Price and volume action is always very important in identifying the strongest stocks during a rally attempt but to make sure that further price gains can be counted on you need to make sure the stocks making the strong moves have strong growing fundamentals. While it isn’t the sexiest industry, pizza is still clearly an area of the economy where steady growth can still be seen.

Let’s take a look at the only two stocks listed on the Nasdaq and NYSE with the word pizza in their company’s name.

The first stock everyone is familiar with is Dominos Pizza (NYSE:DPZ). Dominos Pizza of Ann Arbor, Mich., franchises/operates 9,351 pizza delivery and carry out restaurants in the U.S. and over 65 other countries.

While Dominos Pizza has been around forever, everyone knows that recently it changed pizza recipes and embarked on an ad campaign image overhaul. The outcome was a success with the numbers showing the results.

Sequential EPS growth during the past eight quarters has come in at 89%, 75%, 57%, 53%, 11%, 20%, 21%, and 35%. Sales growth during this time has been steady for an old restaurant operator with gains of 8%, 18%, 14%, 15%, 4%, 2%, 6%, and 8%. The gains are expected to continue with 2011 and 2012 year-over-year EPS estimates at 19% and 12% respectively.

The growth in the EPS and sales over the past eight quarters, with EPS estimates expected to grow and a cash flow of $1.90, are contributors to the rise in the stock's price during this rough market period. It is also a big reason why we have seen mutual fund ownership grow from 236 funds eight quarters ago to 290 currently. It is also good to see that management owns 10% of the shares outstanding, putting its money where its mouth is. It is not often you see management own so much stock of such an old company.

The P/E ratio is a bit high for the “I only buy cheap stocks” crowd but that is not a problem for savvy investors who know P/E ratios have no historical correlation whatsoever to the best performing stocks during a market uptrend. Price Relative Strength and EPS/sales growth has, is, and always will be the most important factor. Currently Dominos Pizza sports a P/E ratio of 18, which is near the top of the 5-year P/E range of 4-19.

The second stock is a thin stock that not too many people are familiar with at all. Pizza Inn Holdings (PZZI). Pizza Inn Holdings from Colony, Texas, is an operator of 218 Pizza Inn restaurants in 17 U.S. southern states and 79 restaurants in 11 foreign countries.

Pizza Inn Holdings is more of a standout based on the powerful price action the past week more than anything else. Dominos Pizza's move today confirmed that someone is eating up all the pizza stock they can get their hands on. Once you dig in a little deeper you can see there are some fundamental reasons for the stock’s recent accumulation.

EPS growth has finally turned a corner the past two quarters with sequential gains of 20% and 400%. Sales growth has turned the corner also with the past four quarters growth coming in at 6%, 0%, 5%, and 10%, following four quarters of losses.

The most impressive financial matrix comes via the company’s return on equity, which is a solid 28%. This comes with only an 8% debt to shareholder equity ratio and a cash flow of $0.28.

These solid financials are the main reasons we see management insiders currently snapping up shares over the past two years, raising their stake to 37% of the shares outstanding. Mutual fund ownership may only be at 7 funds currently but it is higher than the 6 that were invested four quarters ago. With the constant insider buying I am sure we will see more mutual funds get actively involved in this stock.

For the P/E ratio buffs, Pizza Inn Holdings sports a 21 P/E ratio, which is in the lower end of its 5-year range of 5-67. A reminder, once again, that when it comes to making money in the best performing stocks in an uptrend the P/E ratio is irrelevant.

Fundamentals are by far the most important criteria when it comes to which stocks to buy during a market uptrend. However, in an early market uptrend, very strong price momentum being confirmed by large volume is always a bigger factor when deciding what to go long. Technical analysis also helps us find appropriate entry points to minimize our risk and maximize our gains.

Dominos Pizza is currently breaking out of an ascending pennant formation base on very strong volume, giving me a buy signal. Pizza Inn Holdings broke out of a well formed cup with high handle pattern on 10/14 but did not have a lot of volume on the breakout and was not being confirmed by another stock in its group. Dominos Pizza has now confirmed Pizza Inn Holding’s breakout and Pizza Inn Holdings is now 20% higher in just two days.

Pizza Inn will have to either create either another base that is at least three weeks long then breakout on strong volume, signal a pocket-pivot point buy on strong volume off the 10-day moving average, or bounce on heavy volume off the 50-day moving average following a low volume pullback to be considered a long. Right now, it is definitely too extended.

One thing is for sure, America loves pizza. That in and of itself is a pretty solid recipe for these pizza companies to continue producing gains in investor portfolios.

Disclosure: I am long DPZ.