So, the rocky ride continues! The equity markets finally started to rebound, with all three major indices pulling off more than 2% gains last week and then, pow, this week has us right back on the roller coaster.

Selling picked up again because of yesterday’s comments from the Federal Reserve and less-than-stellar economic reports. Yesterday, the Fed pledged once again to keep interest rates at historic lows for “an extended period.” In the accompanying statement, they said the recovery could remain slow, in part because of the debt crisis in Europe.

On the economic front, Wall Street focused on weak numbers in sales of both new and existing homes. (New home sales actually fell to record lows.) And while this morning’s initial jobless claims report showed a decline, it’s clear that employers are not yet ramping up their hiring plans.

None of this is surprising, but when it’s in the headlines, investors react to what they are seeing at that moment. There is no doubt that the underlying economic data is not stellar. There are clear signs of improvement – durable goods orders came out today and were up, as manufacturing continues to show growth – and we have come a long way in many areas since the depths of 2008.

The bears are having a picnic taking the anemic economic data and using it as fodder to drive stocks lower, but here’s what investors forget when sellers are in control: The stock market is forward looking. It is a leading indicator, whereas the economic numbers – especially jobs and housing – are lagging indicators.

What we as investors have to remember is that stocks will move up again before companies feel safe and start to hire employees again, before housing comes back and before the retail spending numbers are solidly back on track.

I expect the economy to continue to recover, albeit slower than we might like, so our job is to take advantage of opportunities to buy breakout stocks at bargain prices, and also to be smart about locking in gains while volatility remains high. I sent you the Flash Alert last Friday to do just that with Vonage (VG) and Orasure (OSUR), and the stocks cooperated beautifully on Monday. They traded above Friday’s close much of the morning, giving you a chance to get out at even bigger gains before they pulled back. (In fact, I’d love to hear what price you were able to get for either or both of these stocks and what your final gains were. Feel free to put the information right in the comments section below.)

We’re also executing on the other part of that strategy by buying stocks at attractive entry points. Last week, we added Citigroup (C) in anticipation of a quick 15%–20% pop in just a few weeks. It has pulled back slightly and remains a good buy while it’s under $4.10.

Today, I want to tell you about another exciting opportunity in a breakout stock that is in a hot sector right now. I’m targeting a double for us.

Next: New Breakout Buy

New Breakout Buy: Wendy’s/Arby’s Group (WEN)

Wendy’s/Arby’s Group (WEN) is a “Tale of Two Franchises.” The Wendy’s portion of the company is a healthy operating fast-food chain, the third-largest burger chain in the world (albeit a distant third behind McDonald’s and Burger King). In contrast, the Arby’s portion of the business is a drag on the company with declining revenues and declining same-store sales that are causing the company to lose money. 

I think that undervalued WEN is a perfect target for a buyout. In fact, this is a true small cap (with a market cap of $430 million) with an attractive business in a sector that has been the target for takeovers by hungry private equity firms. WEN is the type of company that a private equity firm salivates over. There is opportunity to cut the fat, expand internationally and implement a value pricing strategy that can rival McDonalds’s dollar menu.

Let me tell you more about the opportunity in this video Breakout Brief:

I really do expect WEN to be acquired and a new buyer to take advantage of some pretty compelling opportunities. In the video, I mentioned that one of those opportunities is in a breakfast menu. This has actually been in the works for a while.

Along with a consortium of colleagues at other private equity firms, I looked at buying Wendy’s back in 2008 when it was being shopped around by investment bankers. The bankers focused almost exclusively on how adding breakfast to the menu would increase the revenue growth exponentially and help Wendy’s take billions in market share away form other fast-food breakfast providers, namely, Dunkin’ Donuts. I signed a confidentiality letter when looking at the possibility of buying Wendy’s, so I can’t share more than that, but I believed then – and still do – that the key to Wendy’s success will be reducing prices and appealing to children with the equivalent of McDonald’s overwhelmingly popular Happy Meal.

But the big potential here comes in Wendy’s being acquired. Just recently, an “unnamed party” contacted Nelson Peltz, the largest shareholder of WEN and a legendary investor in the food industry, about a possible buyout.  Peltz would be very interested if the price is right. He bought Snapple for $300 million from Quaker in 1997 and then flipped it to Cadbury in 2000 for $1.5 billion. That’s the type of profit that Peltz aims for when he buys a company.

———————————————————————————————————————————————————

Action to Take:

Buy WEN up to $4.50. As I said in the video, I think there’s a good chance the company will be bought for around $10 a share. It could happen in a couple of months or play out over a couple of years. But even if it takes a longer period of time, I expect increased chatter about possible bidders to drive the stock higher in the interim, and we may well get a great opportunity to lock in significant gains long before then.

———————————————————————————————————————————————————

Next: The Russell Effect on Our Stocks

The Russell Effect on SIRI, LLEN, JOEZ and RDNT

As you know, one of the reasons Vonage popped for us was the announcement that it would be included in the Russell 3000 index when it rebalances tomorrow. Actually, Russell Investments is rebalancing various indexes tomorrow, and as a result, it will one of the busiest trading days of the year. Approximately $4.3 trillion tracks the more than two dozen indices compiled by Russell.

Not surprisingly, stocks move as a result. IntelliBusiness is an analytic company that studies stock and index performance, and over the past three annual rebalancings, they observed that stocks to be added to the Russell 3000 gained about 4.6% during the 6-week period prior to the rebalance day. Stocks that are deleted usually fall, and volume increases across the board.

The actually final list of stocks added and subtracted from the indexes will be released by Russell on Monday after the reconstitution event, but based on preliminary announcements, we know that four companies on our Breakout Stocks buy list will be affected by the rebalancing.

Sirius XM Radio (SIRI) will be included in the Russell 1000, Russell Midcap, Russell 2500, Russell 3000 and the Russell Global indexes. The stock has not moved a whole lot on the news, but given its inclusion to so many funds, expect that there may be additional demand for shares as this event hits tomorrow. Also, with SIRI being on so many Russell lists now, the company will enjoy a higher profile, and we may still see some upward momentum. Be aware, as well, that buyers who got in ahead of the rebalancing will probably sell on the news.

L&L Energy (LLEN) and Joe’s Jeans (JOEZ) are also being added to the Russell 3000. Once again, this should give them a higher profile, which will help in the long run. LLEN is up 13% since we launched Breakout Stocks Under $10 on June 1, which correlates to what we just talked about, that the big price action usually happens leading up to the rebalancing. JOEZ ran up in late may and has traded mostly in the $2.10–$2.30 range since then.

Radnet (RDNT) is being removed from the Russell 3000. The stock has, in fact, declined from around $3 to the $2.50 area, so the news appears to be priced in. The selling pressure was actually fairly minimal until this past week when it has dropped about 12%. There was some additional selling today and may be more tomorrow, but my longer-term target of $3.55 remains.

———————————————————————————————————————————————————

Action to Take:

Continue to buy SIRI, JOEZ and RDNT. LLEN is currently above our buy limit. I will be watching all of these stocks extra closely tomorrow. Volume will increase, but nobody will be surprised by the news, and I don’t expect us to have to make any changes as a result.

———————————————————————————————————————————————————

Next: PMI Down on Housing News

PMI Down on Housing News

As I mentioned earlier, the housing numbers were pretty bleak this week, and that is one reason PMI Group (PMI) has fallen close to 20% in the last week. Let me take a moment to tell you what is going on with the stock and why I am personally buying more of it right now.

Yesterday, new single-family home sales dropped by a historic 33% in May. Sales plummeted to a seasonally adjusted rate of 300,000 – the lowest since 1963 when records were first kept. The worst was out in the Western states where sales dropped 50%. The major reason for the fall was the conclusion of the very successful $8,000 subsidy for homebuyers. That’s why economists were counting on at least a 20% drop to a seasonally adjusted 405,000.

Another problem was May’s median sales price, which came in at $200,900, down 9.6% year-over-year.

After showing some resilience earlier in the year because of the tax credit, these numbers were viewed a step backwards. And while we all would have liked to see greater strength, these numbers are not shocking, nor are they indicative of a downward spiral in housing.

Actually, in the midst of the bad news, we got some good news this morning when Freddie Mac announced that that the average rate for the 30-year fixed loan mortgage fell to 4.69% from 4.75% last week. These exceptionally low mortgage rates will have a very positive impact on PMI.

When rates drop to historic levels, qualified buyers come out of the woodwork, especially if prices are also dropping as they are now. Usually prices increase as rates fall because demand picks up. In this case, they are moving in tandem for the moment. The reason is that mortgages are harder to obtain, so sellers don’t have as many buyers flocking to the door. This is one of the lingering effects of the housing bubble and ridiculous lending practices that allowed anyone to lock in a mortgage (sometimes with no documentation!).

Banks have been very hesitant to make loans since the bubble burst, but the credit markets are thawing – albeit slowly – and activity will jump. Many would-be buyers acted before the tax credit expired, but that is now a few months behind us, and rates this low will no doubt lure buyers back into the market. A strengthening employment picture will also help housing, and today’s initial jobless claims report that showed a decrease of 19,000 first-time claims helped reverse the decline and moved PMI up 3%.

Any increase in housing activity will benefit PMI, which insures mortgages for buyers who are putting less than 20% down on their purchase. Coming out of a recession, that will be a sizable group of buyers. Plus, as we talked about, the government is moving out of insuring mortgages, which will also boost PMI’s growth.

As the headlines sparked the selling, technicians piled on when the stock dipped below its 200-day moving average and chartists also dumped the stock. That’s fine if you’re a short-term trader, but to me, this is simply loading the spring for an even stronger bounce.

———————————————————————————————————————————————————

Action to Take:

I am personally buying more PMI at these levels, and I recommend you continue to buy as well. I think it will more than double for us over time.

———————————————————————————————————————————————————

Next: SNV CEO Takes Leave of Absence

SNV CEO Takes Leave of Absence

There were a few interesting developments with Synovus (SNV) this week that I want to tell you about. First, CEO Richard Anthony announced that he will take a leave of absence due to an illness. In his place, the president and COO, Kessel Stelling, Jr., has been named acting CEO.

Management changes are important and cause me to look closely at a stock, but in this case, I see no cause for concern. The change should be temporary, and it is not due to any operational problems or wrongdoing. I will continue to watch the situation, and I know we all hope Mr. Anthony gets well soon.  

The stock also picked up some coverage recently. One sell-side banking analyst expects the stock to move “70%–90% higher to $4.50 to $5.00 over the next two years.” That’s getting close to our $5.50 target.

And on Monday night, Goldman Sachs resumed coverage of SNV with a “neutral” recommendation, but the comments were pretty positive. “The stock offers value as one of the last big regional banks trading below tangible book,” the report said. The company identified catalysts similar to the ones we’re following: a reduction in nonperforming assets, earnings improvement, and “potential reemergence of bank M&A.”

———————————————————————————————————————————————————

Action to Take:

Continue to buy SNV under $3.15. I continue to see the bank’s return to profitability as the major catalyst, which I believe will happen in the second half of this year and drive the stock toward a double. I also expect to see more banking analysts start to comment on this wildly undervalued bank.

———————————————————————————————————————————————————

Sincerely,

Hilary Kramer
Editor, Breakout Stocks Under $10

P.S. As I mentioned earlier, I’d love to know what your final gains were on our recent sales of Vonage and Orasure, and you can share that information with your fellow Breakout Stocks readers and me in the comments section below. Or, as always, feel free to post any other thoughts or questions you may have about our stocks, the market, or investing in general. I always enjoy hearing from you and plan to spend time here on the site responding to your questions.