Wendy's Big Juicy Lesson

Value investors are typically a fickle group. We want screaming bargains, not just a meager discount. When we buy a stock hurt by bad news, we take comfort in knowing that we've built in a margin of safety that ought to keep losses to a minimum if our thesis proves to be wrong. Well, at least most of the time.

Check out this chart for burger maker Wendy's (NYSE: WEN  ) . You'll notice that since March, when a severed finger was discovered in a bowl of chili at a San Jose, Calif., Wendy's, the stock has soared by roughly 20%. That's probably because the incident was proved to be a hoax, perpetrated by a lowly scam artist who has since been arrested.

Indeed, it seems an army of would-be bargain hunters smelled something rotten and decided the stock would rebound. Nice going if you were among the enterprising buyers back then. But if you've been buying in the last month or so, I have a question: Why?

Yesterday Wendy's reported second-quarter sales fell 4.6% at company-owned stores and 3.9% at franchised locations, compared with the same period a year ago.

Certainly the hoax had something to do with the decline, as did rising beef prices. But we already knew both would be factors, right? Then why was the Street looking for comps to be flat or up 1%, as reported in this morning's San Jose Mercury News? Either management wasn't paying attention or the Street wasn't. Or maybe it was a little of both (not surprising). Either way, this is hardly a company that's well on the upturn. Not yet, at least.

Look, I'm as hip as anyone when it comes to the value of buying on bad news. But Wendy's just isn't a bargain. To peek beneath the burger's surface, assume a 12% discount rate, along with growth rates of 12% for years one to five, 6% for years six to 10, and a terminal growth rate of 3%. Plug free cash flow, stock price, and the number of shares outstanding (available from Yahoo! Finance) into the Motley Fool Inside Value discounted cash flow calculator (available to subscribers), and -- the stock is trading close to 20% above intrinsic value.

So, unless you're into giving your portfolio the finger, you might want to drive by Wendy's the next time you go stock shopping.

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Fool contributor Tim Beyers hasn't enjoyed a Wendy's double stack in ages. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what's in his portfolio by checking Tim's Fool profile, which is here. The Motley Fool has a disclosure policy.


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