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Denny’s (Denn): Grand Slam or Get Slammed

June 12, 2014 | About:
David Chulak

David Chulak

29 followers

As a value investor, I try to seek out stocks that have an intrinsic value above what they are currently selling for or have a valuation that has been obviously mispriced by the market. The main requirement is that the stock has a margin of safety high enough for me to consider the investment.

As an insatiable reader, I probably read more from various investment websites and magazines than is probably beneficial or advised, but I love investing and never seem to get enough of it. At times, I pause and reflect whether the writer has truly given me a glimpse of a stock that might deserve further attention or given me what I consider a good laugh at what I would consider an unworthy or ridiculous idea.

In early May, I came across an email linked to an article regarding a stock I had previously done some research on. Most investors understand that there is sometimes a blur between the lines in defining a stock as either a “value” stock or a “growth” stock. Value investors are not afraid of growth; in fact, we love it as much as anyone. Nevertheless, there are some criteria that separate the two concepts. Value investors are not afraid of a stock beaten down but with a potential for recovering to better days. Growth investors seek out “high-flyers” that can generate great returns without concern for valuation and are typically more short term in focus. Even that explanation does not adequately explain the differences, but most investors know which group the stock belongs to. Sometimes, the stock borders between value and growth, a potentially great combination.

The analysis was from a well-known Internet analysis website that most are familiar with. Aside from the fact that the title of the article clearly indicated that this stock wasn’t done growing earnings, the description left me bewildered as to how this could be considered A) a growth stock, B) a high flyer C) a stock that has strong growth potential. Yes, we are talking about Denny’s (DENN). Specifically, the article from the analyst stated:

“….it is important to find companies which are still seeing strong growth prospects in their businesses.”

“One such company that might be well positioned for future earnings growth is Denny’s Corporation (DENN).”

They went on to state that the company had earnings growth of 19.2% last year and is looking to have a respectable 14.2% growth for this year.

….the long-term growth rate is currently an impressive 16.5%, suggesting pretty good prospects for the long haul”. (Emphasis mine)

Denny’s received a Buy rating which highlighted the potential for this stock to be an outperformer.

The analyst concluded with:

“So if you are looking for a fast growing stock that is still seeing plenty of opportunities on the horizon, make sure to consider DENN. Not only does it have double digit earnings growth prospects…”, but better days were ahead for this stock.

Please. While not ready to throw the stock to the sharks and with the full knowledge that there are some improvements by the company, this stock is nowhere ready for primetime consideration for most investors. Denny’s has made some improvements and their annual report indicates future upgrades or ideas which may ultimately help the bottom line.

With that said, the analysis is completely lacking. To indicate a long-term earnings growth at 16.5% is an incredible stretch. What is considered long-term? One or two years? Take a look at the diluted earnings Denny’s has put up. Would you try to value the company with growth at 16.5%?

Is this impressive long-term growth? Not hardly.

Denny’s sports a P/B ratio of 94.8 and a P/E ratio of 24 and even with improving free cash flow numbers is not a stock to be considered anytime soon, certainly as a high-flying growth stock or even a value stock that has recently run upon hard times. This stock needs some work and has some potential, but it cannot be described as a business with strong prospects… not quite yet.

Finally, 2014 does not appear to indicate that people are returning to full sit-down restaurants except perhaps on the weekend. Consumers are being very cautious with their money right now and with higher food prices ahead, this may create additional risk for the business. It is doubtful that Denny’s will be free to increase prices on the menu as these risks increase. As the U.S. ages and is endeavoring to staying healthy, restaurants are creating healthier menus. Check this out.

Put in on your list, follow it, but don’t be caught with this high-flyer or you may just get slammed.

Disclosure: No position

About the author:

David Chulak
David Chulak is a private investor that uses a value approach to investing in the styles of Graham & Dodd and Warren Buffet. Looks for that margin of safety in an effort to preserve capital and attempts to guard against short term market fluctuations by having clear rules laid down in advance for selling an equity. Likes to visit the company's where his investments are in order to understand the business better.

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