The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

03 September 2009

From (seeming) chaos, order

You see a chart like this...

[click on all charts to enlarge]

... and your first cogent thought is, "Keep away!" The thoughts that got you there include, "Sheesh, in near 2 years, all this stock has done is oscillate wildly (~$50 to $66), and got nowhere fast." And, "The stock appears to be breaking down, as it trades beneath its 50 and 200 day simple moving averages." And, finally, "Hey, the 50 day sma points down..." which all lead you to, "Keep away!"

Perhaps more order might be found, if we were to identify a trend or an area pattern. Begin by identifying resistance...

I admit the trend line of lower highs is drawn fairly liberally -- I could tighten it up, thus purchase earlier and at a better price -- but the stock's trading volume will tell me the correct angle of the trend line, and when I should buy. Next I draw the trend line of higher lows, as below...

Okay, now we have something, but what...? Solely because one trend line slopes downward and the other upward, we have delineated a symmetrical triangle. Which is great but for one item: The breakout of symmetrical triangles tend to break in the direction of the primary trend -- but what is this stock's primary trend?

I retain the trend lines and change the periodicity to a weekly basis from daily basis...

Ahh, now the picture offers more clarity; an obvious symmetrical triangle within an extant up trend, and a powerful up trend at that. But wait: the stock rose to $67 from $12 in fewer than 18 months. How do I know this symmetrical triangle, this time, will hold true to form, and continue its upward trajectory? So I change the periodicity to a monthly basis (below)...

And see the entire picture: the symmetrical triangle, identified on the daily basis, confirmed on the weekly basis, now reveals itself to be a mere hesitation after the breakout above the stock's multi-year high level consolidation. (While a tad wide and loose, I understand the plummet to $12; but for extreme exogenous circumstances the stock would probably have held at $20-21.)

The company? McDonalds/MCD. I delve deeper into McDonalds to discern why this stock at this time. And what I find I like. We all know the fundamental story... But do we really? The company's McCafe story ignites a sudden flurry of consumer and investor interest and growth; the company's overall growth story remains dependable, even reliable; an oasis of certainty in an epoch of prevalent uncertainty.

At the current price ($55.57), the stock offers a dividend yield of 3.6% -- nice for a foundational investment. And assuming I have identified correctly the trend lines for the symmetrical triangle, the current price is immediately above its sell stop ($55), although I would grant a little extra leash to $54. The initial upside breakout would occur at $60-$61; the first upside target would be ~$80, and the second objective ~$100. Each objective assumes the bullish resolution of the symmetrical triangle, which should occur soon because the area pattern, as delineated, now is 75% of the way to its apex. This means the stock has coiled to a posture of maximum thrust.

An item or two though before you go. Why do I get to draw the up trend line (in the third chart) as I do? After all, it defies my primary rule for the correct delineation of trend lines. Well, one reason is I expect the bullish resolution of this pattern, so I identify the low prior to the subsequent (expected) higher high. A second reason is that trend line captures sequentially higher lows, a pattern and trend yet to break. Until it does...

The really cool thing for me as an investor is that this long time blue chip growth story, which today is ~20% off its high, can move 50% to 100% in short order, once it breaks out and up. To that return, I can add a dependable 3.6% dividend yield, which serves to sweeten the pie. All that for a measly ~2.5% risk before I must admit my error, and move on.

Full Disclosure: Long McDonalds/MCD.
-- David M Gordon / The Deipnosophist

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